CHAPTER 3: FORECASTING

OPMG 3201 “Operations for Sustainable Advantage” | Fall 2024 | Lecture 5

Dr. Yasmine El-Henawy

School of Business
Department of Management
Forecast

• 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 important to making
informed decisions

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Two Important Aspects of Forecasts

Expected level of Accuracy

demand
The level of demand may be a function Related to the potential size of forecast
of some structural variation such as error
trend or seasonal variation

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 Forecast Uses

Plan the system Plan the use of the

system plans related to:
It involves short- and medium-range
Generally, it involves long-range
plans related to: • Inventory management
• Workforce levels
• Types of products and services to
• Purchasing
offer
• Facility and equipment levels • Production
• Facility location • Budgeting
• Scheduling
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
Forecasts are not
Perfect

Because random variation is always

present, there will always be some residual
error, even if all other factors have been
accounted for.

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Elements of a Good 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
 Steps in the Forecasting Process

1. Determine 2. Establish a 3. Obtain, clean, 4. Select a 5. Make the 6. Monitor the

the purpose of time horizon and analyze forecasting forecast forecast errors
the forecast appropriate technique
data
Forecast Accuracy
and Control
• Allowances should be made for
forecast errors
• 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 errors should be monitored
• Error = Actual – Forecast
• If errors fall beyond acceptable
bounds, corrective action may be
necessary
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Forecast Accuracy Metrics

MAD 
 Actualt  Forecast t MAD weights all errors
evenly
We’ll use MAD
only

 Actual t  Forecast t 
2
MSE weights errors according to
MSE  their squared values
n 1

Actual t  Forecast t
 Actual t
100 MAPE weights errors according to
MAPE  relative error
n
Forecast Error Calculation

Actual Forecast (A-F)

Period |Error| Error2 [|Error|/Actual]x100
(A) (F) Error

1 107 110 -3 3 9 2.80%

2 125 121 4 4 16 3.20%

3 115 112 3 3 9 2.61%

4 118 120 -2 2 4 1.69%

5 108 109 1 1 1 0.93%

Sum 13 39 11.23%

n=5 n-1 = 4 n=5

MAD MSE MAPE

= 2.6 = 9.75 = 2.25%

Forecasting Approaches

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

• Forecasts that use subjective inputs such as opinions from consumer surveys, sales staff,
managers, executives, and experts

• Executive opinions
• a small group of upper-level managers may meet and collectively develop a forecast

• Sales force opinions

• members of the sales or customer service staff can be good sources of information due to
their direct contact with customers and may be aware of plans customers may be
considering for the future

• Consumer surveys
• since consumers ultimately determine demand, it makes sense to solicit input from them
• consumer surveys typically represent a sample of consumer opinions

• Other approaches
• managers may solicit opinions from other managers or staff people or outside experts to 3-13
help with developing a forecast.
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

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 Time-Series Behaviors

• Trend
• Seasonality
• Cycles
• Irregular variations
• Random variation
Trends and Seasonality

Trend Seasonality
A long-term upward or downward Short-term, fairly regular variations
movement in data related to the calendar or time of day
• Population shifts
• Changing income
Cycles and Variations

• Cycle
• Wavelike variations lasting more than one year
• These are often related to a variety of economic, political, or
even agricultural conditions
• Irregular variation
• Due to unusual circumstances that do not reflect typical behavior
• Labor strike
• Weather event
• Random Variation
• Residual variation that remains after all other behaviors have been
accounted for
Time-Series
Forecasting - Naïve
Forecast
• 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 with
• a stable time series
• seasonal variations
• trend
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:
1. Moving average
2. Weighted moving average
3. Exponential smoothing
 Moving Average

A technique that averages the number of the most recent actual values in
generating a forecast
n

A t i
At  n  ...  At  2  At  1
Ft MA n  i 1

n n
where
Ft Forecast for time period t
MA n n period moving average
At  i Actual value in period t  i
n Number of periods in the moving average
Moving Average

• As new data become available, the forecast is updated by adding the

newest value and dropping the oldest and then re-computing 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
Weighted Moving Average

• 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
Ft wt ( At )  wt  1 ( At  1 )  ...  wt  n ( At  n )
where
wt weight for period t , wt  1 weight for period t  1, etc.
At the actual value for period t , At  1 the actual value for period t  1, etc.
 Exponential Smoothing

• A weighted averaging method that is based on the previous forecast plus a

percentage of the forecast error

Ft Ft  1   ( At  1  Ft  1 )
where
Ft Forecast for period t
Ft  1 Forecast for the previous period
 = Smoothing constant
At  1 Actual demand or sales from the previous period
 In Class Exercise

• The Instant Paper Clip Office Supply Company sells and delivers office
supplies to companies, schools, and agencies within a 50-mile radius of
its warehouse. The office supply business is competitive, and the ability
to deliver orders promptly is a big factor in getting new customers and
maintaining old ones. (Offices typically order not when they run low on
supplies, but when they completely run out. As a result, they need their
orders immediately.) The manager of the company wants to be certain
that enough drivers and vehicles are available to deliver orders
promptly and that they have adequate inventory in stock. Therefore, the
manager wants to be able to forecast the demand for deliveries during
the next month. From the records of previous orders, management has
accumulated the following data for the past 10 months:
Mont Jan Feb Mar Apr Ma Jun Jul Au Se Oct
h y g p
Order 12 90 100 75 11 50 75 13 11 90
s 0 0 0 0
 Compute the demand forecast for
November

Mont Jan Feb Mar Apr Ma Jun Jul Au Se Oct

h y g p
Order 12 90 100 75 11 50 75 13 11 90
s 0 0 0 0

a. Using the naive method.

b. Using a 3-month moving average.
c. Using a 3-month weighted moving average. Use weights of 0.5, 0.33,
and 0.17, with the heavier weights on the more recent months.
d. Using exponential smoothing with smoothing parameter α = 0.3,
knowing that the forecast of May is 105
 Solution

a. F(11)= A(10) = 90
b. F(11)= = = 110
c. F(11) = 0.5(90) + 0.33(110) + 0.17(130) = 103.4
d. Ft+1 = Ft + α(At − Ft).
Mont Ja Fe Ma Ap Ma Ju Jul Au Se Oct
I have May‘s forecast so I‘ll start from June
h n b r r y n g p
F(6) = 105 + 0.3(110 – 105)= 106.5 Order 12 90 100 75 11 50 75 13 110 90
s 0 0 0
F(7) = 106.5 +0.3(50 – 106.5) = 89.55
F(8) = 89.55 + 0.3(75 – 89.55) = 85.18
F(9) = 85.18 + 0.3(130 – 85.185) =98.62
F(10) = 98.62 + 0.3(110 – 98.62) = 102.03
F(11)= 102.03 + 0.3(90 – 102.03) = 98.42
 Linear Trend

Ft a  bt
where
Ft Forecast for period t
a Value of Ft at t 0
A simple data plot can reveal b Slope of the line
the existence and nature of t Specified number of time periods from t 0
a trend
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 Slope and intercept can be
estimated from historical data
Estimating
slope and b
n  ty 
 t y

intercept n  t   t 
2
2

a
 y  b t
or y  bt
n
where
n Number of periods
y Value of the time series
Freight car loadings over an 18-week
period at a busy port are as follows

a) Determine a linear trend line for expected freight car loadings.

b) Use the trend equation to predict expected loadings for
weeks 20 and 21.
F = 208.444 + (19)(20) = 588.444
F = 208.444 + (19)(21) = 607.444
C) The manager intends to install new equipment when the
volume exceeds 800 loadings per week. Assuming the
current trend continues, the loading volume will reach that
level in approximately what week?

= = 31.1 weeks
 Factors to consider
• Cost
Choosing a • Accuracy
Forecasting •
•
Availability of historical data
Availability of forecasting
Technique software
• Time needed to gather and
analyze data and prepare a
forecast
• Forecast horizon

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Operations Strategy

• The better forecasts are, the more able

organizations will be to take advantage of
future opportunities and reduce potential risks
• A worthwhile strategy is to work to improve
short-term forecasts
• Accurate up-to-date information can
have a significant effect on forecast
accuracy:
• Prices
• Demand
• Other important variables
• Reduce the time horizon forecasts have to
cover
• Sharing forecasts or demand data through
the
supply chain can improve forecast quality