Operations Management: Sustainability and Supply Chain Management

Operations Management: Sustainability
and Supply Chain Management

Twelfth Edition
Chapter 4
Forecasting
Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved
8
Learning Objectives (1 of 2)
4.1 Understand the three time horizons and
which models apply for each
4.2 Explain when to use each of the four
qualitative models
4.3 Apply the naive, moving-average,
exponential smoothing, and trend methods
9
Learning Objectives (2 of 2)
4.4 Compute three measures of forecast accuracy
4.5 Develop seasonal indices
4.6 Conduct a regression and correlation analysis
4.7 Use a tracking signal
10
What Is Forecasting?
• Process of predicting
a future event
• Underlying basis of
all business decisions
– Production
– Inventory
– Personnel
– Facilities
11
Forecasting Time Horizons

1. Short-range forecast
– Up to 1 year, generally less than 3 months
– Purchasing, job scheduling, workforce levels, job
assignments, production levels
2. Medium-range forecast
– 3 months to 3 years
– Sales and production planning, budgeting
3. Long-range forecast
– 3+ years
– New product planning, facility location, research
and development
12
Distinguishing Differences
1. Medium/long range forecasts deal with more
comprehensive issues and support management
decisions regarding planning and products, plants and
processes
2. Short-term forecasting usually employs different
methodologies than longer-term forecasting
3. Short-term forecasts tend to be more accurate than
longer-term forecasts
13
Influence of Product Life Cycle

Introduction – Growth – Maturity – Decline
• Introduction and growth require longer forecasts
than maturity and decline
• As product passes through life cycle, forecasts are
useful in projecting
– Staffing levels
– Inventory levels
– Factory capacity
16
Types of Forecasts
1. Economic forecasts
– Address business cycle – inflation rate, money
supply, housing starts, etc.
2. Technological forecasts
– Predict rate of technological progress
– Impacts development of new products
3. Demand forecasts
– Predict sales of existing products and services
17
Strategic Importance of Forecasting

• Supply-Chain Management – Good supplier relations,
advantages in product innovation, cost and speed to
market
• Human Resources – Hiring, training, laying off workers
• Capacity – Capacity shortages can result in
undependable delivery, loss of customers, loss of market
share
18
Seven Steps in Forecasting

1. Determine the use of the forecast
2. Select the items to be forecasted
3. Determine the time horizon of the forecast
4. Select the forecasting model(s)
5. Gather the data needed to make the forecast
6. Make the forecast
7. Validate and implement the results
20
Forecasting Approaches (1 of 2)
Qualitative Methods
• Used when situation is vague and little data exist
– New products
– New technology
• Involves intuition, experience
– e.g., forecasting sales on Internet
21
Forecasting Approaches (2 of 2)
Quantitative Methods
• Used when situation is ‘stable’ and historical data
exist
– Existing products
– Current technology
• Involves mathematical techniques
– e.g., forecasting sales of color televisions
22
Overview of Qualitative Methods (1 of 2)
1. Jury of executive opinion

– Pool opinions of high-level experts, sometimes
augmented by statistical models
2. Delphi method
– Panel of experts, queried iteratively
23
Overview of Qualitative Methods (2 of 2)
3. Sales force composite

– Estimates from individual salespersons are reviewed
for reasonableness, then aggregated
4. Market Survey
– Ask the customer
28
Overview of Quantitative Approaches

1. Naive approach
2. Moving averages
3. Exponential smoothing
4. Trend projection
5. Linear regression
29
Time-Series Forecasting
• Set of evenly spaced numerical data
– Obtained by observing response variable at regular
time periods
• Forecast based only on past values, no other variables
important
– Assumes that factors influencing past and present will
continue influence in future
30
Time-Series Components
37
Moving Averages
• MA is a series of arithmetic means
• Used if little or no trend
• Used often for smoothing
– Provides overall impression of data over time
Moving average 
 demand in previous n periods
n
38
Moving Average Example
Donna’s Garden Supply wants a 3-month moving-average forecast, including a

forecast for next January, for shed sales.
39
Weighted Moving Average (1 of 3)

• Used when some trend might be present
– Older data usually less important
• Weights based on experience and intuition
Weighted
moving     Weight for period n   Demand in period n  
average  Weights
40
Donna’s Garden Supply wants to forecast storage shed sales by weighting the past 3
months, with more weight given to recent data to make them more significant.
41
42
Exercise
Sales of hair dryers at the Walgreens stores in Youngstown,Ohio, over
the past 4 months have been 100, 110, 120, and 130 units (with 130
being the most recent sales).
Develop a moving-average forecast for next month, using
these three techniques:
a) 3-month moving average.
b) 4-month moving average.
c) Weighted 4-month moving average with the most recent month
weighted 4, the preceding month 3, then 2, and the oldest month
weighted 1.
d) If next month’s sales turn out to be 140 units, forecast the following
month’s sales (months) using a 4-month moving average.
43
Solution
44
Potential Problems with Moving Average

1. Increasing n smooths the forecast but makes it less
sensitive to changes
2. Does not forecast trends well
3. Requires extensive historical data
46
Exponential Smoothing (1 of 2)
• Form of weighted moving average
– Weights decline exponentially
– Most recent data weighted most
• Requires smoothing constant (α)
– Ranges from 0 to 1
– Subjectively chosen
• Involves little record keeping of past data
47
Exponential Smoothing (2 of 2)
New forecast = Last period’s forecast + α (Last

period’s actual demand − Last period’s forecast)
Ft  Ft 1 +   A t 1  Ft 1 
where Ft = new forecast

Ft – 1 = previous period’s forecast
α= smoothing (or weighting)
constant  0    1
At – 1 = previous period’s actual demand
48
Exponential Smoothing Example (1 of 3)

Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant α = .20
49

Actual demand = 153
New forecast  142  .2(153  142)
50

Actual demand = 153
New forecast  142  .2(153  142)

 142  2.2
 144.2  144 cars
51
Effect of Smoothing Constants
• Smoothing constant generally .05  α  .50

As α increases, older values become less significant
52
Impact of Different  (1 of 2)
53
Impact of Different  (2 of 2)
• Choose high values of  when underlying average is
likely to change
• Choose low values of  when underlying average is
stable
55
Common Measures of Error

Mean Absolute Deviation (MAD)
MAD 
 | Actual  Forecast
n
56
Determining the MAD (1 of 2)

During the past 8 quarters, the Port of Baltimore has unloaded large quantities of grain from
ships. The port’s operations manager wants to test the use of exponential smoothing to see how
well the technique works in predicting tonnage unloaded. He guesses that the forecast of grain
unloaded in the first quarter was 175 tons. Two values of smoothing constant, a are to be
examined: a = .10 and a = .50.
Actual
Tonnage Forecast With
Quarter Unloaded Forecast With a = .10 a = .50
1 180 175 175
2 168 175.50 = 175.00 + .10(180 − 175) 177.50
3 159 174.75 = 175.50 + .10(168 − 175.50) 172.75
4 175 173.18 = 174.75 + .10(159 − 174.75) 165.88
5 190 173.36 = 173.18 + .10(175 − 173.18) 170.44
6 205 175.02 = 173.36 + .10(190 − 173.36) 180.22
7 180 178.02 = 175.02 + .10(205 − 175.02) 192.61
8 182 178.22 = 178.02 + .10(180 − 178.02) 186.30
9 ? 178.59 = 178.22 + .10(182 − 178.22) 184.15
57
Determining the MAD (2 of 2)

To evaluate the accuracy of each smoothing constant, we can compute forecast errors
in terms of absolute deviations and MADs:
A smoothing constant of a = .10 is preferred because its MAD is

smaller
58
Common Measures of Error (1 of 2)

Mean Squared Error (MS)
  Forecast errors 
2
MSE 
n
59
Determining the MSE

The operations manager for the Port of Baltimore now wants to compute MSE
for a = .10.
  Forecast errors 
2
MSE=  1,526.52 8  190.8

n
70
Exponential Smoothing with Trend

Adjustment (1 of 3)
When a trend is present, exponential smoothing must be modified.
Assume that demand for our product or service has been increasing by
100 units per month and that we have been forecasting with a = 0.4 in
our exponential smoothing model.
Month Actual Demand Forecast (Ft) For Months 1 5
1 100 F1 = 100 (given)
2 200 F2 = F1 + α(A1 F1) = 100 + .4(100 100) = 100
3 300 F3 = F2 + α (A2 F2) = 100 + .4(200 100) = 140
4 400 F4 = F3 + α (A3 F3) = 140 + .4(300 140) = 204
5 500 F5 = F4 + α (A4 F4) = 204 + .4(400 204) = 282
71
Exponential Smoothing with Trend Adjustment (2 of 3)
Forecast including trend (FITt) = Exponentially smoothed

forecast (Ft) + Exponentially smoothed trend (Tt)
Ft  α  At 1  +  1 α   Ft 1 + Tt 1 
Tt  β  Ft  Ft 1  +  1 β  Tt 1
Where Ft = exponentially smoothed forecast average

Tt = exponentially smoothed trend
At = actual demand
α = smoothing constant for average
 0  α  1
β = smoothing constant for trend  0  β  1
72

Adjustment (3 of 3)
Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast FITt = Ft + Tt
73

Adjustment Example (1 of 6)
A large Portland manufacturer wants to forecast demand for a
piece of pollution-control equipment. A review of past sales, as
shown below, indicates that an increasing trend is present:
Month (t) Actual Demand (At) Month (t) Actual Demand (At)
1 12 6 21
2 17 7 31
3 20 8 28
4 19 9 36
5 24 10 ?
α=. β=.
2 4
74

75

Table 4.2 Forecast with α = .2 and β = .4
76

77

78

79

80

We will also do the same calculations for the third month:
Step 1: F3 = aA2 + (1 - a)(F2 + T2) = (.2)(17) + (1 - .2)(12.8 + 1.92)

= 3.4 + (.8)(14.72) = 3.4 + 11.78 = 15.18
Step 2: T3 = b(F3 - F2) + (1 - b)T2 = (.4)(15.18 - 12.8) + (1 - .4)(1.92)

= (.4)(2.38) + (.6)(1.92) = .952 + 1.152 = 2.10
Step 3: FIT3 = F3 + T3
= 15.18 + 2.10 = 17.28.
81

Smoothed
Forecast Average, Smoothed Forecast Including
Month Actual Demand Ft Trend, Tt Trend, Fitt
1 12 11 2 13.00
2 17 12.80 1.92 14.72
3 20 15.18 2.10 17.28
4 19 17.82 2.32 20.14
5 24 19.91 2.23 22.14
6 21 22.51 2.38 24.89
7 31 24.11 2.07 26.18
8 28 27.14 2.45 29.59
9 36 29.28 2.32 31.60
10 — 32.48 2.68 35.16
82

Figure 4.3 Exponential Smoothing with Trend-Adjustment Forecasts
Compared to Actual Demand Data
83
Trend Projections
Fitting a trend line to historical data points to project into

the medium to long-range
Linear trends can be found using the least squares
technique
Λ
y  a  bx
Λ
where y  computed value of the variable to
be predicted (dependent variable)
a = y-axis intercept
b = slope of the regression
line
x = the independent variable
84
Least Squares Method (1 of 2)

Figure 4.4 The Least-Squares Method for Finding the Best-Fitting
Straight Line, Where the Asterisks Are the Locations of the Seven
Actual Observations or Data Points
Least squares method minimizes the sum of the squared errors

(deviations)
85
Least Squares Method (2 of 2)

• Equations to calculate the regression variables
ŷ=a+ bx
b=
å xy- nxy
å x - nx 2 2
a =y- bx
86
Least Squares Example (1 of 4)
Electrical Electrical
Year Power Demand Year Power Demand
1 74 5 105
2 79 6 142
3 80 7 122
4 90 Blank Blank
87
Electrical Power
Year (x) x2 xy
Demand (y)
1 74 1 74
2 79 4 158
3 80 9 240
4 90 16 360
5 105 25 525
6 142 36 852
7 122 49 854
sum of y = 692. sum of x squared = sum of xy = 3,063
sum of x = 28 140.
 x  28  y  692  x  140
2
 xy  3,063
88
x
 x  28  4 y
 y  692  98.86
n 7 n 7
b
 xy  nxy 3,063   7   4   98.86  295
   10.54
 x  nx 140   7   4 
2 2
2 28
a  y  bx  98.86  10.54  4   56.70


Thus, y  56.70  10.54 x
Demand in year 8 = 56.70 + 10.54(8)

= 141.02, or 141 megawatts
89

Figure 4.5 Electrical Power and the Computed Trend Line
90
Exercise
91
Solution
106
Adjusting Trend Data
yˆ seasonal  Index  yˆ trendforcast
Quarter I: yÎ  (1.30)($100,000)  $130,000

Quarter II: yÎI  (.90)($120,000)  $108,000
Quarter III: yÎII  (.70)($140,000)  $98,000
Quarter IV: yÎV  (1.10)($160,000)  $176,000
107
Cyclical Variations
• Cycles – patterns in the data that occur every several
years
– Forecasting is difficult
– Wide variety of factors
108
Associative Forecasting (1 of 2)
Used when changes in one or more independent
variables can be used to predict the changes in the
dependent variable
Most common technique is linear-regression
analysis
We apply this technique just as we did in the
time-series example
109
Associative Forecasting (2 of 2)
Forecasting an outcome based on predictor variables using

the least squares technique
Λ
y  a  bx
Λ
where y  value of the dependent variable (in our example,
sales)
a = y-axis intercept
b = slope of the regression
line
x = the independent variable
110
Associative Forecasting Example (1 of 6)

Nodel Construction Company renovates old homes in West Bloomfield,
Michigan. Over time, the company has found that its dollar volume of
renovation work is dependent on the West Bloomfield area
payroll. Management wants to establish a mathematical relationship to
help predict sales.
Nodel’s Sales Area Payroll Nodel’s Sales Area Payroll

(In $ Millions), y (In $ Billions), x (In $ Millions), y (In $ Billions), x
2.0 1 2.0 2
3.0 3 2.0 1
2.5 4 3.5 7
111

Nodel’s Sales Area Payroll Nodel’s Sales Area Payroll
(In $ Millions), y (In $ Billions), x (In $ Millions), y (In $ Billions), x
2.0 1 2.0 2
3.0 3 2.0 1
2.5 4 3.5 7
112
Sales, y Payroll, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
the sum of Y= 15.0 the sum of X = 18 the sum of X squared = 18 the sum of X Y = 51.5
 y  15.0  x  18  x 2  18  xy  51.5
x
 x  18  3 y
 y  15  2.5
6 6 6 6
113
Sales, y Payroll, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
the sum of Y= 15.0 the sum of X = 18 the sum of X squared = 18 the sum of X Y = 51.5
 y  15.0  x  18  x 2  18  xy  51.5
b
 xy  nxy 51.5   6   3   2.5 
  .25 a  y  bx  2.5   .25   3   1.75
 x  nx 80   6   3 
2 2 2
114

y  1.75  .25 x
Sales  1.75  .25  payroll 
115
116

If payroll next year is estimated to be $6 billion, then:
Sales  in $ millions   1.75  .25  6 

 1.75  1.5  3.25
Sales  $3,250,000
138
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Operations Management: Sustainability

and Supply Chain Management

Forecasting Time Horizons

Influence of Product Life Cycle

Strategic Importance of Forecasting

Seven Steps in Forecasting

Overview of Qualitative Methods (1 of 2)

1. Jury of executive opinion

– Panel of experts, queried iteratively

Overview of Qualitative Methods (2 of 2)

3. Sales force composite

– Ask the customer

Overview of Quantitative Approaches

Donna’s Garden Supply wants a 3-month moving-average forecast, including a

Weighted Moving Average (1 of 3)

Weighted Moving Average (2 of 3)

Weighted Moving Average (3 of 3)

Potential Problems with Moving Average

New forecast = Last period’s forecast + α (Last

where Ft = new forecast

Exponential Smoothing Example (1 of 3)

Exponential Smoothing Example (2 of 3)

New forecast  142  .2(153  142)

Exponential Smoothing Example (3 of 3)

New forecast  142  .2(153  142)

• Smoothing constant generally .05  α  .50

Common Measures of Error

Determining the MAD (1 of 2)

Determining the MAD (2 of 2)

A smoothing constant of a = .10 is preferred because its MAD is

Common Measures of Error (1 of 2)

Determining the MSE

MSE=  1,526.52 8  190.8

Exponential Smoothing with Trend

Month Actual Demand Forecast (Ft) For Months 1 5

1 100 F1 = 100 (given)

2 200 F2 = F1 + α(A1 F1) = 100 + .4(100 100) = 100

3 300 F3 = F2 + α (A2 F2) = 100 + .4(200 100) = 140

4 400 F4 = F3 + α (A3 F3) = 140 + .4(300 140) = 204

5 500 F5 = F4 + α (A4 F4) = 204 + .4(400 204) = 282

Forecast including trend (FITt) = Exponentially smoothed

Where Ft = exponentially smoothed forecast average

Exponential Smoothing with Trend

Exponential Smoothing with Trend

Exponential Smoothing with Trend

Exponential Smoothing with Trend

Exponential Smoothing with Trend

Exponential Smoothing with Trend

Exponential Smoothing with Trend

Exponential Smoothing with Trend

Exponential Smoothing with Trend

We will also do the same calculations for the third month:

Step 1: F3 = aA2 + (1 - a)(F2 + T2) = (.2)(17) + (1 - .2)(12.8 + 1.92)

Step 2: T3 = b(F3 - F2) + (1 - b)T2 = (.4)(15.18 - 12.8) + (1 - .4)(1.92)

Exponential Smoothing with Trend

Exponential Smoothing with Trend

Fitting a trend line to historical data points to project into

Least Squares Method (1 of 2)

Least squares method minimizes the sum of the squared errors