3-1Forecasting CHAPTER 3 Forecasting Homework Problems: # 2,3,4,8(a),22,23,25,27 on pp

3-2Forecasting  Forecast – a statement about the future value of a variable of interest  We make forecasts about such things as weather, demand, and resource availability  Forecasts are an important element in making informed decisions Forecast

3-3Forecasting AccountingCost/profit estimates FinanceCash flow and funding Human ResourcesHiring/recruiting/training MarketingPricing, promotion, strategy MISIT/IS systems, services OperationsSchedules, MRP, workloads Product/service designNew products and services Uses of Forecasts

3-4Forecasting Two Important Aspects of Forecasts  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

3-5Forecasting I see that you will get an A this semester. Features Common to All Forecasts 1. Techniques assume some underlying causal system that existed in the past will persist into the future 2. Forecasts are not perfect 3. Forecasts for groups of items are more accurate than those for individual items 4. Forecast accuracy decreases as the forecasting horizon increases

3-6Forecasting 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

3-7Forecasting Steps in the Forecasting Process 1. Determine the purpose of the forecast 2. Establish a time horizon 3. Select a forecasting technique 4. Obtain, clean, and analyze appropriate data 5. Make the forecast 6. Monitor the forecast

3-8Forecasting Types of Forecasts  Judgmental - uses subjective inputs  Time series - uses historical data assuming the future will be like the past  Associative models - uses explanatory variables to predict the future

3-9Forecasting Forecast Accuracy and Control  Forecasters want to minimize forecast errors  It is nearly impossible to correctly forecast real-world variable values on a regular basis  So, it is important to provide an indication of the extent to which the forecast might deviate from the value of the variable that actually occurs  Forecast accuracy should be an important forecasting technique selection criterion

3-10Forecasting Forecast Accuracy and Control (contd.)  Forecast errors should be monitored  Error = Actual – Forecast  If errors fall beyond acceptable bounds, corrective action may be necessary

3-11Forecasting Forecast Accuracy Metrics MAD weights all errors evenly MSE weights errors according to their squared values MAPE weights errors according to relative error

3-12Forecasting Forecast Error Calculation Period Actual (A) Forecast (F) (A-F) Error |Error|Error 2 [|Error|/Actual]x % % % % % Sum % n = 5n-1 = 4n = 5 MADMSEMAPE = 2.6= 9.75= 2.25%

3-13Forecasting Forecasting Approaches  Qualitative Forecasting  Qualitative techniques permit the inclusion of soft information such as:  Human factors  Personal opinions  Hunches  These factors are difficult, or impossible, to quantify  Quantitative Forecasting  Quantitative techniques involve either the projection of historical data or the development of associative methods that attempt to use causal variables to make a forecast  These techniques rely on hard data

3-14Forecasting Judgmental Forecasts  Forecasts that use subjective inputs such as opinions from consumer surveys, sales staff, managers, executives, and experts  Executive opinions  Sales force opinions  Consumer surveys  Delphi method

3-15Forecasting Time Series Forecasts  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

3-16Forecasting Time Series Forecasts  Trend - long-term movement in data  Seasonality - short-term regular variations in data  Cycle – wavelike variations of more than one year’s duration  Irregular variations - caused by unusual circumstances  Random variations - caused by chance

3-17Forecasting Forecast Variations Trend Irregular variatio n Seasonal variations Figure 3.1 Cycles

3-18Forecasting Naive Forecasts  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  Can be used when  The time series is stable  There is a trend  There is seasonality

3-19Forecasting Time-Series Forecasting-- Averaging  These Techniques work best when a series tends to vary about an average  Averaging techniques smooth variations in the data  They can handle step changes or gradual changes in the level of a series  Techniques  Moving average  Weighted moving average  Exponential smoothing

3-20Forecasting Moving Averages  Technique that averages a number of the most recent actual values in generating a forecast

3-21Forecasting Moving Averages  As new data become available, the forecast is updated by adding the newest value and dropping the oldest and then recomputing 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

3-22Forecasting Weighted Moving Averages  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

3-23Forecasting Moving Averages Example Given the following data: Period # of complaints A). Prepare the forecasts for period 6 using a 3- period, 5-period moving average. B). Prepare a weighted moving average forecast for period 6 using weights of 0.3, 0.2, and 0.1.

3-24Forecasting Simple Moving Average Actual MA3 MA5 Q. What n to use? Large or small?

3-25Forecasting Exponential Smoothing Premise--The most recent observations might have the highest predictive value.  Therefore, we should give more weight to the more recent time periods when forecasting. F t = F t-1 +  ( A t-1 - F t-1 )

3-26Forecasting Exponential Smoothing  Weighted averaging method based on previous forecast plus a percentage of the forecast error  A-F is the error term,  is the % feedback F t = F t-1 +  ( A t-1 - F t-1 )

3-27Forecasting Example - Exponential Smoothing

3-28Forecasting Picking a Smoothing Constant .1 .4 Actual

3-29Forecasting Other Forecasting Methods - Focus  Focus Forecasting  Some companies use forecasts based on a “best current performance” basis  Apply several forecasting methods to the last several periods of historical data  The method with the highest accuracy is used to make the forecast for the following period  This process is repeated each month

3-30Forecasting Other Forecasting Methods - Diffusion  Diffusion Models  Historical data on which to base a forecast are not available for new products  Predictions are based on rates of product adoption and usage spread from other established products  Take into account facts such as  Market potential  Attention from mass media  Word-of-mouth

3-31Forecasting Technique for Trend  Linear trend equation  Non-linear trends  Parabolic trend equation  Exponential trend equation  Growth curve trend equation

3-32Forecasting Linear Trend Equation  A simple data plot can reveal the existence and nature of a trend  Linear trend equation

3-33Forecasting Estimating slope and intercept  Slope and intercept can be estimated from historical data

3-34Forecasting Linear Trend Equation Example

3-35Forecasting Linear Trend Calculation y = t a= (15) 5 = b= 5 (2499)- 15(812) 5(55)- 225 = =

3-36Forecasting Associative Forecasting  Home values may be related to such factors as home and property size, location, number of bedrooms, and number of bathrooms  Associative techniques are based on the development of an equation that summarizes the effects of predictor variables  Predictor variables - variables that can be used to predict values of the variable of interest

3-37Forecasting Simple Linear Regression  Regression - a technique for fitting a line to a set of data points  Simple linear regression - the simplest form of regression that involves a linear relationship between two variables  The object of simple linear regression is to obtain an equation of a straight line that minimizes the sum of squared vertical deviations from the line (i.e., the least squares criterion)

3-38Forecasting Least Squares Line Predictor

3-39Forecasting Standard Error  Standard error of estimate  A measure of the scatter of points around a regression line  If the standard error is relatively small, the predictions using the linear equation will tend to be more accurate than if the standard error is larger

3-40Forecasting Linear Model Seems Reasonable A straight line is fitted to a set of sample points. Computed relationship

3-41Forecasting Correlation Coefficient  Correlation  A measure of the strength and direction of relationship between two variables  Ranges between and  r 2, square of the correlation coefficient  A measure of the percentage of variability in the values of y that is “explained” by the independent variable  Ranges between 0 and 1.00

3-42Forecasting Regression and Correlation Example  Given the following values of X and Y, (a) obtain a linear regression line for the data, and (2) what percentage of the variation is explained by the regression line?  xyxyx2y2             

3-43Forecasting Simple Linear Regression Assumptions 1. Variations around the line are random 2. Deviations around the average value (the line) should be normally distributed 3. Predictions are made only within the range of observed values

3-44Forecasting Issues to consider  Always plot the line to verify that a linear relationships is appropriate  The data may be time-dependent.  If they are  use analysis of time series  use time as an independent variable in a multiple regression analysis  A small correlation may indicate that other variables are important

3-45Forecasting Controlling the Forecast  Control chart  A visual tool for monitoring forecast errors  Used to detect non-randomness in errors  Forecasting errors are in control if  All errors are within the control limits  No patterns, such as trends or cycles, are present

3-46Forecasting Sources of Forecast errors  Model may be inadequate  Irregular variations  Incorrect use of forecasting technique

3-47Forecasting Choosing a Forecasting Technique  No single technique works in every situation  Two most important factors  Cost  Accuracy  Other factors include the availability of:  Historical data  Computers  Time needed to gather and analyze the data  Forecast horizon

3-48Forecasting Using Forecast Information  Reactive approach  View forecasts as probable future demand  React to meet that demand  Proactive approach  Seeks to actively influence demand  Advertising  Pricing  Product/service modifications  Generally requires either and explanatory model or a subjective assessment of the influence on demand