Operations Forecasting

Chapter Objectives

At the end of this chapter you will be

able to:
• Define the concept and the need for forecasting
• Describe the qualities good forecast.
• Explain the steps involved in the forecasting
process.
• Identify types of forecasting methods and their
characteristics.
Meaning of Operations forecasting
Forecasting is estimating the future demand for products and
the resources necessary to produce these outputs.

Implementing a forecasting system enables you to assess

current market trends and sales quickly so that to make
informed decisions about the operations.

Hence, the starting point for all other forecasts are Sales
forecasts.

It becomes an input of both business strategy and production

strategy. Thus, it is an integral part of planning.
 Why Operations forecasting?

Forecasting is required to
determine the following issues
• What products to produce?
• What service to offer?
• How many units to purchase?
• How many units to produce?
Features of Good Forecasting

 The forecast horizon must cover the sufficient time

necessary to implement possible changes.
 The degree of accuracy should be stated.
 The forecast should be expressed in meaningful
units.
 The forecast should presented in writing.
 The forecast should be simple to understand and
use, or consistent with historical data intuitively.
 Steps in the Forecasting Process

“The forecast”

Step 6 Monitor the forecast

Step 5 Make the forecast
Step 4 Gather and analyze data
Step 3 Select a forecasting technique
Step 2 Establish a time horizon
Step 1 Determine purpose of forecast
 Forecasting Techniques

Method of forecasting

Qualitative Quantitative
techniques techniques
 I. Qualitative Methods
 Qualitative methods :consist mainly of subjective
inputs
 It based on Judgment of forecaster
II. Quantitative approaches
• Forecasts generated through mathematical
modelling.
 Involves either Time series or Associative
models
 Time series - uses historical data assuming the
future will be like the past
 Associative models - uses explanatory variables to
predict the future.
 Brainstorming question

 Based on your opinion or experience which

forecasting technique is best?
I. Qualitative(Judgmental Forecasts)
 Consumer surveys=asking preference
 Delphi method= using experts opinion.
 Executive opinions:- Opinions of managers and
staff
 Sales force.
 The sales staff is often a good source of information
because of its direct contact with customers and experience
 Jury of executive opinions
 A small group of upper-level managers may meet
and collectively develop a forecast
 Relatively quick
 ‘Group-think’
 Forecasts based on judgment, experience or
opinions are appropriate when:
 Forecasts must be prepared quickly in a short period
of time
 Available data may be obsolete or up to date
information might not be available because of rapid
and continuous changes in the external environment
such as economic and political conditions
 Historical data cannot be available like demand for a
newly introduced product, and
 The forecasting period is long range that past events
will not repeat themselves in a similar fashion
 Types of Quantitative Forecasts

Time series analysis

Simple Mean or A verage
i. Simple Moving Average
ii. Weighted Moving Average
iii. Exponential Smoothing

Associative/causal models
Regression Analysis
 Simple Mean or Average

A simple moving average is obtained by summing

and averaging values from a given number of
periods repetitively
Consequently the ‘forecast’ moves by reflecting
only the most recent values.
 Cont’d
…
 At 3  ...  At 
At 1  At  2
SMA = Ft = n n

= 
i 1
A t i

Where
n
SMA – simple moving average
Ft - Forecast for period t
At-i - Actual demand in
period t-i
n - Number of periods
(data points) in the moving
average
Example 1:

A food processor uses a moving average to forecast next month’s demand.

Past actual demand (in units) is shown in the following table

Month 1 2 3 4 5 6 7 8
Actual demand 105 106 110 110 114 121 130 128

Compute a simple 5 month

moving average to forecast demand for
month 9
Solution

128130121114110
a) SMA = F =
9 9

5
= 120.6
Therefore, the forecasted demand for month 9 is
120.6.
 ii. Weighted Moving average

In weighted moving average, the weight is given in

such a way that more weight is given to the most
recent value in the time series.

Ft = WMA = W1At-1+W2.At-2+… +Wn. At-n

n
= A t  1 .W i
Where 
i 1

Ft =forecast in time t
WMA = weighted moving average
W = weight
A = Actual demand value
 Example 1

A department store may find that in a four month period

the best forecast is derived by using 40% of the actual
demand for the most recent month, 30% two months
ago, 20% of three months ago and 10% of four months
ago. The actual demands were as follows.
Month Month 1 Month 2 Month 3 Month 4

Actual Demand 100 90 105 95

Compute weighted 4-month MA for month 5

 Solutio
n
• Compute weighted 4-month MA for month 5

WMA = 95x0.4+105x0.3+90x0.2+100x0.10

= 97.5 units
 iii) Simple Exponential Smoothing

• With simple exponential smoothing, the forecast is

made up of the last period forecast plus a portion of
the difference between the last period actual demand
and the last period forecast.
Mathematically
• Ft = F t-1 + α(At-1 - F t-1)

Where
• Ft = Forecast for period t
• Ft-1 = Forecast for the previous period
• α = Smoothing constant (0< α <1)
• A t-1 = Actual demand for the previous
period
Example
• The production supervisor at a fibreboard
plant uses a simple exponential
smoothing technique (α = 0.2) to forecast
demand.
• In May, the forecast was for 20 shipments
and the actual demand was for 25
shipments rather than 20. If the actual
demand for June is 26 shipments,
forecast the demand for June and July?
 Demand for June
F = FMay + a (AMay –FMay)
june
= 20+0.2(25-20)
= 21
The actual for June was 26 shipments
forecast the demand for July.

F =F +a(A –F )
july june june june
= 21+0.2(26-21)
= 22
 Casual Forecasting Method
• Casual forecasting techniques rely on identification of related
variables that can be used to predict values of the
variable of interest (demand).

Casual methods are used when historical data are

available and there is relationship between the factors to
be forecasted.
Example
• Sales volume are usually related to
 promotion
 Quality
 price
• Regression :- measures the
rate of change in one (the
dependent) variable
associated with a given
change in the other
(independent) variable.
Simple Linear regression
In simple linear regression, only one
independent variable is used and the model
takes the form

Y = a + bx

Where
• Y = predicted (dependent) variable,
demand a = value of Y at X = 0
• b = slope of the line
The coefficients a and b of the line are obtained by using the formula

b= n.xy  x.y
n.x2 
(x)2
a=
y  bx
n , or y 
bx of Period Observations
n = Number
 Example

The general manager of a building materials

production plant feels the demand for plaster
board shipments may be related to the number
of constructions permits issued in the country
during the previous quarter. The manager has
collected the data shown in the accompanying
table.
Construction Plaster board
permits shipments
15 6
9 4
40 16
20 6
25 13
25 9
15 10
35 16
Required:

Derive a regression forecasting equation?

Determine plasterboard demand when the number

construction permit is
• 30
• 35
• 40

Compute coefficient of determination (r2) and

interpret the result.
 a) To derive the regression forecasting equation, first let’s find
the values of the Coefficients a and b

X Y XY X2 Y2
15 6 90 225 36
9 4 36 81 16
40 16 640 1600 256
20 6 120 400 36
25 13 325 625 139
25 9 225 625 81
15 10 150 225 100
35 16 560 1225 256
x=184 y=80 xy=2146 x2=5006  y2=950
 n = 8 pairs of observation

n.xy 
b=
x.y n.x 2
 (x)2

8x
=
2146184
2448 x80
= 619  0.395
8 x5006
2
(184)2
y  80  0.39(184)
a = = =
bx 8 0.915
n
Thus, the regression equation is;
• Y = a + bx

→ Y = 0.915 + 0.395x

B) plasterboard demand,

i) if no of permit = 30
• Y = 0.915 + 0.395 (30) = 12.76

= 13 shipments
if number of permit = 35

Y = 0.915 + 0.395 (35)

• = 14.74 = 15 shipments

if number of permit = 40
Y = 0.915 + 0.395 (40)
• = 16.75 = 17 shipments
C) Coefficient of correlation and determination
n.xy
Coefficient of correlation (r) =
 n.x2 
x.y
x2 ny
2 2

8x
y 
r=
 
8 x 950
2146184x80
8 x 5006 1842 2

80 

2448
x 
r=
2,430,400

r = 0.90  r2 = 0.81
Interpretation

* r2 = 0.81 means 81 percent of the total variation in

plasterboard shipments is explained by construction
permits.

What remains is the coefficient of determination (i.e.

0.19). It indicates that 19% of the total variation, which
remains unexplained, is due to the factors other than
the number of construction permit.
Note: Correlation coefficient, r is a number between -1 &
1.Correlation coefficient can be positive, zero or negative.

• r = 1 perfect positive relation.

• r = 0 lack of any relationship between the two variables. r =-1 perfect
negative relationship.

Coefficient of correlation, r overstates the degree of relationship.

Thus, we use coefficient of determination, r2. Coefficient of
determination, r2 ranges from 0 and 1, and it is a more objective
and definitive measure of the degree of relationship.
 End of
Chapter
Four!!!