McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. 3 Forecasting

3-2 Learning Objectives  List the elements of a good forecast.  Outline the steps in the forecasting process.  Describe at least three qualitative forecasting techniques and the advantages and disadvantages of each.  Compare and contrast qualitative and quantitative approaches to forecasting.

3-3 Learning Objectives  Briefly describe averaging techniques, trend and seasonal techniques, and regression analysis, and solve typical problems.  Describe two measures of forecast accuracy.  Describe two ways of evaluating and controlling forecasts.  Identify the major factors to consider when choosing a forecasting technique.

3-4 FORECAST:  A statement about the future value of a variable of interest such as demand.  Forecasting is used to make informed decisions.  Long-range  Short-range

3-5 Forecasts  Forecasts affect decisions and activities throughout an organization  Accounting, finance  Human resources  Marketing  MIS  Operations  Product/service design

3-6 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

I see that you will get an A this semester. 3-7  Assumes causal system past ==> future  Forecasts rarely perfect because of randomness  Forecasts more accurate for groups vs. individuals  Forecast accuracy decreases as time horizon increases Features of Forecasts

3-8 Elements of a Good Forecast Timely Accurate Reliable Meaningful Written Easy to use

3-9 Steps in the Forecasting Process Step 1 Determine purpose of forecast Step 2 Establish a time horizon Step 3 Select a forecasting technique Step 4 Obtain, clean and analyze data Step 5 Make the forecast Step 6 Monitor the forecast “The forecast”

3-10 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

3-11 Judgmental Forecasts  Executive opinions  Sales force opinions  Consumer surveys  Outside opinion  Delphi method  Opinions of managers and staff  Achieves a consensus forecast

3-12 Time Series Forecasts  Trend: long-term movement in data  Seasonality: short-term regular variations in data  Cycles: wavelike variations of more than one year’s duration  Irregular variations: caused by unusual circumstances  Random variations: caused by chance

3-13 Forecast Variations Trend Irregular variation Seasonal variations Figure 3.1 Cycles

3-14 Naive Forecasts Uh, give me a minute.... We sold 250 wheels last week.... Now, next week we should sell.... The forecast for any period equals the previous period’s actual value.

3-15  Simple to use  Virtually no cost  Quick and easy to prepare  Data analysis is nonexistent  Easily understandable  Cannot provide high accuracy  Can be a standard for accuracy Naive Forecasts

3-16 Uses of Naive Forecasts Stable time series data F(t) = A(t-1)

3-17 Uses of Naive Forecasts Data with trends

3-18 Naive Forecasts: Predict using stable, seasonal and trends

3-19  Stable time series data  F(t) = A(t-1)  Seasonal variations  F(t) = A(t-n)  Data with trends  F(t) = A(t-1) + (A(t-1) – A(t-2)) Uses of Naive Forecasts

3-20 Techniques for Averaging  Moving average  Weighted moving average  Exponential smoothing

3-21 Moving average 1.Forecast September sales by using five-month moving average 2.A weighted average using.60 for August,.30 for July, and.10 for June..6 (20) +.3(22) +.1(18) = 20.4

3-22 Moving average Example 1 : page 77 Example 2 : page 79

3-23 Moving average Exponential smoothing with a smoothing constant equal to.20. Assuming a march forecast of 19(000)

3-24 Exponential smoothing Exercise: Problem 4 page 115

3-25 Techniques for averaging

3-26 Moving Averages  Moving average: A technique that averages a number of recent actual values, updated as new values become available.  Weighted moving average: More recent values in a series are given more weight in computing the forecast. F t = MA n = n A t-n + … A t-2 + A t-1 F t = WMA n = n w n A t-n + … w n-1 A t-2 + w 1 A t-1

3-27 Simple Moving Average Actual MA3 MA5 F t = MA n = n A t-n + … A t-2 + A t-1

3-28 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 )

3-29 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 )

3-30 Example 3: Exponential Smoothing

3-31 Picking a Smoothing Constant .1 .4 Actual

3-32 Common Nonlinear Trends Parabolic Exponential Growth Figure 3.5

3-33 Linear Trend Equation  F t = Forecast for period t  t = Specified number of time periods  a = Value of F t at t = 0  b = Slope of the line F t = a + bt t FtFt

3-34 Calculating a and b b = n(ty) - ty nt 2 - ( t) 2 a = y - bt n   

3-35 Linear Trend Equation Example

3-36 Linear Trend Calculation y = t a= (15) 5 = b= 5 (2499)- 15(812) 5(55)- 225 = =

3-37 Associative Forecasting  Predictor variables: used to predict values of variable interest  Regression: technique for fitting a line to a set of points  Least squares line: minimizes sum of squared deviations around the line

3-38 Linear Model Seems Reasonable A straight line is fitted to a set of sample points. Computed relationship

3-39 Linear Regression Assumptions  Variations around the line are random  Deviations around the line normally distributed  Predictions are being made only within the range of observed values  For best results:  Always plot the data to verify linearity  Check for data being time-dependent  Small correlation may imply that other variables are important

3-40 Forecast Accuracy  Error: difference between actual value and predicted value  Mean Absolute Deviation (MAD)  Average absolute error  Mean Squared Error (MSE)  Average of squared error  Mean Absolute Percent Error (MAPE)  Average absolute percent error

3-41 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

3-42 Operations Strategy  Forecasts are the basis for many decisions  Work to improve short-term forecasts  Accurate short-term forecasts improve  Profits  Lower inventory levels  Reduce inventory shortages  Improve customer service levels  Enhance forecasting credibility

3-43 Supply Chain Forecasts  Sharing forecasts with supply can  Improve forecast quality in the supply chain  Lower costs  Shorter lead times