Operations

Management
Chapter 4 –
Forecasting

PowerPoint presentation to accompany

Heizer/Render
Principles of Operations Management, 7e
Operations Management, 9e
© 2008 Prentice Hall, Inc. 4–1
 Forecasting Defined
• “Art & science of predicting future events
for planning purposes”
• Can be subjective or intuitive
• Can use historical data and mathematical
modeling
• Used to:
– Determine resources needed, schedule existing
resources & acquire additional resources
– Anticipate changes in prices/costs
– Prepare for new laws/regulations, competitors,
resource shortages or technologies
• Generally driven by customer demand
© 2008 Prentice Hall, Inc. 4–2
 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
© 2008 Prentice Hall, Inc. 4–3
 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

© 2008 Prentice Hall, Inc. 4–4

 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
• Also called sales forecasts
• Drive production, capacity, purchasing & scheduling
systems and serves as inputs to financial, marketing,
and personnel planning
© 2008 Prentice Hall, Inc. 4–5
 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

© 2008 Prentice Hall, Inc. 4–6

 Seven Steps in Forecasting
• Determine the use of the forecasting
ABC Co uses demand forecasts to drive production at each of its 13 plants
• Select the items to be forecasted
– Units of measure – number of cars vs. total sales
• Determine the time horizon of the forecast
– Short-, medium-, or long-range
• Select the type of forecasting technique
– Qualitative vs. quantitative
• Gather the data needed to make the forecast
• Make the forecast
• Validate and implement the results
– Check assumptions with affected departments (stakeholders)
– Use forecast to schedule materials, etc.

© 2008 Prentice Hall, Inc. 4–7

 Forecasting Approaches
Qualitative Methods
– Incorporates intuition, emotion, personal
experiences, & value systems
– Used when adequate historical data is
lacking
– Relies on managerial judgment/experience
– Can be used to modify forecasts generated
by quantitative methods

© 2008 Prentice Hall, Inc. 4–8

 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 LCD TVs

© 2008 Prentice Hall, Inc. 4–9

 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

© 2008 Prentice Hall, Inc. 4 – 10

 Overview of Qualitative
Methods
 Sales force composite
 Estimates from individual
salespersons are reviewed for
reasonableness, then aggregated
 Consumer Market Survey
 Ask the customer

© 2008 Prentice Hall, Inc. 4 – 11

 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

© 2008 Prentice Hall, Inc. 4 – 12

 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

© 2008 Prentice Hall, Inc. 4 – 13

 Delphi Method
 Iterative group Decision Makers
(Evaluate
process, responses and
continues until make decisions)
consensus is
reached Staff
(Administering
 3 types of survey)
participants
 Decision makers
 Staff Respondents
(People who can
 Respondents make valuable
judgments)
© 2008 Prentice Hall, Inc. 4 – 14
 Consumer Market Survey

 Ask customers about purchasing

plans
 What consumers say, and what
they actually do are often different
 Sometimes difficult to answer

© 2008 Prentice Hall, Inc. 4 – 15

 Overview of Quantitative
Approaches
1. Naive approach
2. Moving averages
Time-Series
3. Exponential Models
smoothing
4. Trend projection
Associative
5. Linear regression Model

© 2008 Prentice Hall, Inc. 4 – 16

 Time Series Components

Trend Cyclical

Seasonal Random

© 2008 Prentice Hall, Inc. 4 – 17

 Components of Demand
Trend
component
Demand for product or service

Seasonal peaks

Actual
demand

Average
demand over
Random four years
variation
| | | |
1 2 3 4
Year Figure 4.1
© 2008 Prentice Hall, Inc. 4 – 18
 Trend Component
 Persistent, overall upward or
downward pattern
 Changes due to population,
technology, age, culture, etc.
 Typically several years
duration

© 2008 Prentice Hall, Inc. 4 – 19

 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
© 2008 Prentice Hall, Inc. 4 – 20
 Cyclical Component
 Patterns in the data that occur every several
years.
 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
© 2008 Prentice Hall, Inc. 4 – 21
© 2008 Prentice Hall, Inc. 4 – 22
 Random Component
 Unpredictable, unsystematic,
‘residual’ fluctuations
 Due to random variation or
unforeseen events
 Short duration and
nonrepeating

M T W T F
© 2008 Prentice Hall, Inc. 4 – 23
 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

© 2008 Prentice Hall, Inc. 4 – 24

 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

© 2008 Prentice Hall, Inc. 4 – 25

 Moving Average Example
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

© 2008 Prentice Hall, Inc. 4 – 26

 Graph of Moving Average
Moving
Average
30 –
28 –
Forecast
26 – Actual
24 – Sales
Shed Sales

22 –
20 –
18 –
16 –
14 –
12 –
10 –
| | | | | | | | | | | |
J F M A M J J A S O N D

© 2008 Prentice Hall, Inc. 4 – 27

 Weighted Moving Average
 Used when trend is present
 Older data usually less important
 Weights based on experience and
intuition

∑ (weight for period n)

Weighted x (demand in period n)
moving average = ∑ weights

© 2008 Prentice Hall, Inc. 4 – 28

 Weights Applied Period
Weighted Moving
3 Average
Last month
2 Two months ago
1 Three months ago
6 Sum of weights

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

© 2008 Prentice Hall, Inc. 4 – 29

 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

© 2008 Prentice Hall, Inc. 4 – 30

 Moving Average And
Weighted Moving Average
Weighted
moving
30 – average
25 –
Sales demand

20 – Actual
sales
15 –
Moving
10 – average

5 –
| | | | | | | | | | | |
Figure 4.2
J F M A M J J A S O N D

© 2008 Prentice Hall, Inc. 4 – 31

 Exponential Smoothing
 A weighted moving average forecasting
technique in which data points are
weighted by an exponential function
 Requires smoothing constant ()
 Ranges from 0 to 1
 Subjectively chosen
 Involves little record keeping of past
data

© 2008 Prentice Hall, Inc. 4 – 32

 Exponential Smoothing

st 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)
© 2008 Prentice Hall, Inc. 4 – 33
 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

© 2008 Prentice Hall, Inc. 4 – 34

 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

© 2008 Prentice Hall, Inc. 4 – 35

 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars

© 2008 Prentice Hall, Inc. 4 – 36