Forecasting

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

You should be able to:1. List the elements of a good forecast2. Outline the steps in the forecasting process3. Describe at least three qualitative forecasting techniques

and the advantages and disadvantages of each4. Compare and contrast qualitative and quantitative

approaches to forecasting5. Describe averaging techniques, trend and seasonal

techniques, and regression analysis, and solve typical problems

6. Explain three measures of forecast accuracy7. Compare two ways of evaluating and controlling

forecasts8. Assess the major factors and trade-offs to consider when

choosing a forecasting technique

3-2Student Slides

Forecast – a statement about the future value of a variable of interestWe make forecasts about such things as

weather, demand, and resource availabilityForecasts are an important element in making

informed decisions

3-3Student Slides

n

100

ActualForecastActual

MAPE t

tt

n

tt ForecastActualMAD

2tt

1ForecastActual

MSE

n

MAD weights all errors evenly

MSE weights errors according to their squared values

MAPE weights errors according to relative error

3-4Student Slides

Forecasts that project patterns identified in recent time-series observationsTime-series - a time-ordered sequence of

observations taken at regular time intervalsAssume that future values of the time-series

can be estimated from past values of the time-series

3-5Student Slides

These Techniques work best when a series tends to vary about an averageAveraging techniques smooth variations in the

dataThey can handle step changes or gradual

changes in the level of a seriesTechniques

1. Moving average2. Weighted moving average3. Exponential smoothing

3-6Student Slides

Technique that averages a number of the most recent actual values in generating a forecast

average moving in the periods ofNumber 1 periodin valueActual

average moving period MA period for timeForecast

where

MA

1

1

ntA

ntF

n

AF

t

n

t

n

iit

nt

3-7Student Slides

The most recent values in a time series are given more weight in computing a forecastThe choice of weights, w, is somewhat

arbitrary and involves some trial and error

etc. ,1 periodfor valueactual the , periodfor valueactual theetc. ,1 periodfor weight , periodfor weight

where)(...)()(

1

1

11

tAtAtwtw

AwAwAwF

tt

tt

ntntttttt

3-8Student Slides

A weighted averaging method that is based on the previous forecast plus a percentage of the forecast error

period previous thefrom salesor demand Actualconstant Smoothing=

period previous for theForecast periodfor Forecast

where)(

1

1

111

t

t

t

tttt

A

FtF

FAFF

3-9Student Slides

A simple data plot can reveal the existence and nature of a trend

Linear trend equation

Ft a btwhere Ft Forecast for period t aValue of Ft at t 0 bSlope of the line t Specified number of time periods from t 0

3-10Student Slides

Slope and intercept can be estimated from historical data

bn ty t yn t 2 t

2

ay b tn

or y bt

where n Number of periods y Value of the time series

3-11Student Slides

The trend adjusted forecast consists of two componentsSmoothed errorTrend factor

TAFt+1 St Ttwhere St Previous forecast plus smoothed error Tt Current trend estimate

3-12Student Slides

Alpha and beta are smoothing constantsTrend-adjusted exponential smoothing has

the ability to respond to changes in trend

TAFt+1 St Tt St TAFt + At TAFt Tt Tt 1 TAFt TAFt 1 Tt 1

3-13Student Slides

Regression - a technique for fitting a line to a set of data pointsSimple linear regression - the simplest form of

regression that involves a linear relationship between two variablesThe 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)

3-14Student Slides

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

forecastsAccurate up-to-date information can have a

significant effect on forecast accuracy:PricesDemandOther important variables

Reduce the time horizon forecasts have to cover Sharing forecasts or demand data through the

supply chain can improve forecast quality

3-15Student Slides