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Forecasting
Dr. Muhammad Rizwan Khan

PRODUCTION ENGINEERING & OPERATIONS MANAGEMENT LAB

What is a Forecast?
Forecast
• A prediction of future events used for planning purposes.
Qualitative Forecast Methods:
• Subjective methods. Qualitative forecast methods are based on
judgment, opinion, past experience, or best guesses, to make
forecasts.
Quantitative Forecast Methods:
• Quantitative forecast methods are based on mathematical
formulas.
• Several quantitative forecasting methods are available to aid
management in making planning decisions.
Forecast Methods

The traditional types of mathematical forecasting methods are:

• Time series analysis and regression,

• Nonmathematical, qualitative approaches to forecasting.

Although no technique will result in a totally accurate forecast,

these methods can provide reliable guidelines in making
decisions.

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COMPONENTS OF FORECASTING DEMAND
Time frame: indicates how far into the future is forecast.

Forecasts are either short- to mid-range, or long-range.

Short- to mid-range forecast:

• Typically encompasses the immediate future—daily up to two years.
• Short-range (to mid-range) forecasts are typically for daily, weekly, or monthly sales demand for up
to approximately two years into the future, depending on the company and the type of industry.
• They are primarily used to determine production and delivery schedules and to establish inventory
levels.
Long-range forecast:
• A long-range forecast is usually for a period longer than two years into the future.
• A long-range forecast is normally used for strategic planning
• to establish long-term goals, plan new products for changing markets, enter new markets, develop
new facilities, develop technology, design the supply chain, and implement strategic programs.
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DEMAND BEHAVIOR
Demand sometimes behaves in a random, irregular way.

At other times it exhibits predictable behavior, with trends or repetitive

patterns, which the forecast may reflect.

The five types of demand behavior are

1. Horizontal,
2. Trends,
3. Seasonal,
4. Cyclical,
5. Random.

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Demand Patterns
Horizontal. The fluctuation of data around a constant mean.

Trend. The systematic increase or decrease in the mean of the series

over time.

Seasonal. A repeatable pattern of increases or decreases in demand,

depending on the time of day, week, month, or season.

Cyclical. The less predictable gradual increases or decreases in

demand over longer periods of time (years or decades).
Random. The unforecastable variation in demand.

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Demand Patterns
The four patterns of demand—horizontal, trend, seasonal, and
cyclical—combine in varying degrees to define the underlying time
pattern of demand for a service or product.
The fifth pattern, random variation, results from chance causes and
thus, cannot be predicted.

Random variation is an aspect of demand that makes every forecast

ultimately inaccurate.

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Demand Patterns

Quantity

Time

(a) Horizontal: Data cluster about a horizontal line

Demand Patterns

Quantity

Time

(b) Trend: Data consistently increase or decrease

Demand Patterns

Year 1
Quantity

Year 2

| | | | | | | | | | | |
J F M A M J J A S O N D
Months
(c) Seasonal: Data consistently show peaks and valleys
Demand Patterns

Quantity

| | | | | |
1 2 3 4 5 6
Years
(d) Cyclical: Data reveal gradual increases and decreases over
extended periods
FORECASTING METHODS
• Types of methods:
1. Time series,
2. Causal,
3. Qualitative.
• Time series methods are statistical techniques that use historical demand data to predict
future demand.
• Regression (or causal) forecasting methods attempt to develop a mathematical relationship
(in the form of a regression model) between demand and factors that cause it to behave the
way it does.
• Qualitative (or judgmental) methods use management judgment, expertise, and opinion to
make forecasts. Often called “the jury of executive opinion,” they are the most common
type of forecasting method for the long-term strategic planning process.
• There are normally individuals or groups within an organization whose judgments and
opinions regarding the future are as valid or more valid than those of outside experts or
other structured approaches.
• Top managers are the key group involved in the development of forecasts for strategic
plans.
• They are generally most familiar with their firms’ own capabilities and resources and the
markets for their products. 12
Delphi Method

Delphi method: involves soliciting forecasts about

technological advances from experts.

The Delphi method is a procedure for acquiring informed

judgments and opinions from knowledgeable individuals
using a series of questionnaires to develop a consensus
forecast about what will occur in the future.
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FORECASTING PROCESS
• Forecasting is not simply identifying and using
a method to compute a numerical estimate of
what demand will be in the future.
• It is a continuing process that requires
constant monitoring and adjustment.

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 4. Select a forecast
1. Identify the 2. Collect historical 3. Plot data and
model that seems
purpose of forecast data identify patterns
appropriate for data

5. 7. Is 8b. Select new

6. Check forecast
Develop/Compute accuracy of forecast model or
accuracy with one
forecast for period forecast No adjust parameter of
or more measures
of historical data acceptable? existing model

Yes

9. Adjust forecast
based on additional 10. Monitor results
8a. Forecast over
qualitative and measure
planning horizon
information and forecast accuracy
insight
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Time Series Methods
Time series methods:
• Use historical demand data over a period of time to predict future
demand.
• Statistical techniques that make use of historical data accumulated over
a period of time.
• Time series methods assume that what has occurred in the past will
continue to occur in the future.
• As the name time series suggests, these methods relate the forecast to
only one factor—time.
• These methods assume that identifiable historical patterns or trends for
demand over time will repeat themselves.
• They include the moving average, exponential smoothing, and linear
trend line; and they are among the most popular methods for short-
range forecasting among service and manufacturing companies.
Time Series Methods

•Naïve Forecast
• The forecast for the next period equals the demand for the
current period (Forecast = Dt)
•Horizontal Patterns: Estimating the average
• Simple moving average
• Weighted moving average
• Exponential smoothing
Simple Moving Averages
• Specifically, the forecast for period t + 1 can be calculated at the end of period t
(after the actual demand for period t is known) as:

Sum of last n demands Dt + Dt-1 + Dt-2 + … + Dt-n+1

Ft+1 = =
n n

Where,
Dt = actual demand in period t
n = total number of periods in the average
Ft+1 = forecast for period t + 1
Example 1:
a) Compute a three-week moving average forecast for the arrival of
medical clinic patients in week 4. The numbers of arrivals for the past
three weeks were as follows:
Week Patient Arrivals
1 400
2 380
3 411

b) If the actual number of patient arrivals in week 4 is 415, what is the

forecast error for week 4?
c) What is the forecast for week 5?
Example 1:
Week Patient Arrivals
a. The moving average forecast at 1 400
the end of week 3 is: 2 380
3 411
411 + 380 + 400
F4 = = 397.0
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b. The forecast error for week 4 is
E4 = D4 – F4 = 415 – 397 = 18

c. The forecast for week 5 requires the actual arrivals from

weeks 2 through 4, the three most recent weeks of data

415 + 411 + 380

F5 = = 402.0
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Application 1:
Estimating with Simple Moving Average using the
following customer-arrival data:
Month Customer arrival
1 800
2 740
3 810
4 790
Use a three-month moving average to forecast customer arrivals
for month 5
D4 + D3 + D2 790 + 810 + 740
F5 = = = 780
3 3

Forecast for month 5 is 780 customer arrivals

Application 1:
If the actual number of arrivals in month 5 is 805, what
is the forecast for month 6?

Month Customer arrival

1 800
2 740
3 810
4 790
D5 + D4 + D3 805 + 790 + 810
F6 = = = 801.667
3 3

Forecast for month 6 is 802 customer arrivals

Application 1:
Forecast error is simply the difference found by subtracting
the forecast from actual demand for a given period, or

Et = Dt – Ft

Given the three-month moving average forecast for

month 5, and the number of patients that actually
arrived (805), what is the forecast error?

E5 = 805 – 780 = 25

Forecast error for month 5 is 25

Weighted Moving Averages
• In the simple moving average method, each demand has the same
weight in the average—namely,1Τ𝑛.
• In the weighted moving average method, each historical demand in the
average can have its own weight.
• The sum of the weights equals 1.0.
• For example, in a three-period weighted moving average model, the
most recent period might be assigned a weight of 0.50, the second
most recent might be weighted 0.30, and the third most recent might
be weighted 0.20.
• The average is obtained by multiplying the weight of each period by the
value for that period and adding the products together:
Ft+1 = W1D1 + W2D2 + … + WnDt-n+1
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Application 2:
Using the customer arrival data in Application 1, let
W1 = 0.50, W2 = 0.30, and W3 = 0.20. Use the weighted
moving average method to forecast arrivals for month 5.

F5 = W1D4 + W2D3 + W3D2

= 0.50(790) + 0.30(810) + 0.20(740) = 786
Forecast for month 5 is 786 customer arrivals.
Given the number of customers that actually arrived (805),
what is the forecast error?
E5 = 805 – 786 = 19
Forecast error for month 5 is 19.
Application 2:

If the actual number of arrivals in month 5 is 805,

compute the forecast for month 6:

F6 = W1D5 + W2D4 + W3D3

= 0.50(805) + 0.30(790) + 0.20(810)

= 801.5

Forecast for month 6 is 802 customer arrivals.

Advantages of Weighted Moving Average
• The advantage of a weighted moving average method is that it allows
you to emphasize recent demand over earlier demand.
• It can even handle seasonal effects by putting higher weights on prior
years in the same season.
• The forecast will be more responsive to changes in the underlying
average of the demand series than the simple moving average forecast.

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Exponential Smoothing
• A sophisticated weighted moving average that calculates the average of a time series by
implicitly giving recent demands more weight than earlier demands
• Requires only three items of data
• The last period’s forecast
• The demand for this period
• A smoothing parameter, alpha (α), where 0 ≤ α ≤ 1.0
• The equation for the forecast is
Ft+1 = α(Demand this period) + (1 – α)(Forecast calculated last period)
= αDt + (1 – α)Ft
• The emphasis given to the most recent demand levels can be adjusted by changing the
smoothing parameter.
• Larger α values emphasize recent levels of demand and result in forecasts more
responsive to changes in the underlying average.
• Smaller α values treat past demand more uniformly and result in more stable forecasts.
Forecast Error
• For any forecasting method, it is important to measure the accuracy of its
forecasts.
• Forecasts almost always contain errors.
• Random error results from unpredictable factors that cause the forecast to
deviate from the actual demand.
• Forecasting analysts try to minimize forecast errors by selecting appropriate
forecasting models but eliminating all forms of errors is impossible.
• Forecast error is simply the difference found by subtracting the forecast from
actual demand for a given period, or

where Et = Dt – Ft
Et = forecast error for period t
Dt = actual demand in period t
Ft = forecast for period t
Measures of Forecast Error
There are five basic measures of forecast error: CFE, MSE, , MAD, and MAPE.
• The cumulative sum of forecast errors (CFE) measures the total forecast error.
• The average forecast error, sometimes called the mean bias, is simply.
• The mean squared error (MSE), standard deviation of the errors (), and mean absolute
deviation (MAD) measure the dispersion of forecast errors attributed to trend, seasonal,
cyclical, or random effects.
• The mean absolute percent error (MAPE) relates the forecast error to the level of demand
and is useful for putting forecast performance in the proper perspective:
Standard deviation
Cumulative sum of forecast errors (Bias)
(Et – Ē ) 2
CFE = Et =
n– 1
Average forecast error Mean Absolute Deviation
Ē=
CFE |Et |
n MAD = n
Mean Squared Error Mean Absolute Percent Error
Et2 (|Et |/ Dt)(100)
MSE = n MAPE = n
Example:
The following table shows the actual sales of upholstered chairs for a furniture
manufacturer and the forecasts made for each of the last eight months.
Calculate CFE, MSE, σ, MAD, and MAPE for this product.
Month Demand Forecast Error Error2 Absolute Absolute % Error
t Dt Ft Et Et2 Error |Et| (|Et|/Dt)(100)

1 200 225 –25

2 240 220 20

3 300 285 15

4 270 290 –20

5 230 250 –20 400 20 8.7

6 260 240 20 400 20 7.7

7 210 250 –40 1,600 40 19.0

8 275 240 35 1,225 35 12.7

Total –15 5,275 195 81.3%

Example:
The following table shows the actual sales of upholstered chairs for a furniture
manufacturer and the forecasts made for each of the last eight months.
Calculate CFE, MSE, σ, MAD, and MAPE for this product.

Month Demand Forecast Error Error2 Absolute Absolute % Error

t Dt Ft Et Et2 Error |Et| (|Et|/Dt)(100)
1 200 225 –25 625 25 12.5%
2 240 220 20 400 20 8.3
3 300 285 15 225 15 5.0
4 270 290 –20 400 20 7.4
5 230 250 –20 400 20 8.7
6 260 240 20 400 20 7.7
7 210 250 –40 1,600 40 19.0
8 275 240 35 1,225 35 12.7
Total –15 5,275 195 81.3%
Example:
Using the formulas for the measures, we get:

Cumulative forecast error (mean bias)

CFE = –15
Average forecast error (mean bias):
CFE 15
Ē = n = = –1.875
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Mean squared error:
Et2 5,275
MSE = = = 659.4
n 8
Example:
Standard deviation:
[Et – (–1.875)]2
= = 27.4
n–1

Mean absolute deviation:

|Et | 195
MAD = n = = 24.4
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Mean absolute percent error:
(Et |/ Dt)(100) 81.3%
MAPE = n = = 10.2%
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Example
• A CFE of –15 indicates that the forecast has a slight bias to overestimate demand.
• The MSE, σ, and MAD statistics provide measures of forecast error variability.
• A MAD of 24.4 means that the average forecast error was 24.4 units in absolute value.
• The value of σ, 27.4, indicates that the sample distribution of forecast errors has a
standard deviation of 27.4 units.
• A MAPE of 10.2 percent implies that, on average, the forecast error was about 10
percent of actual demand.
These measures become more reliable as the number of periods of data increases.
Problem:
The Polish General’s Pizza Parlor is a small restaurant catering to patrons with a
taste for European pizza. One of its specialties is Polish Prize pizza. The manager
must forecast weekly demand for these special pizzas so that he can order pizza
shells weekly. Recently, demand has been as follows:
Week Pizzas Week Pizzas
June 2 50 June 23 56
June 9 65 June 30 55
June 16 52 July 7 60

a. Forecast the demand for pizza for June 23 to July 14 by using the simple moving
average method with n = 3 then using the weighted moving average method with
and weights of 0.50, 0.30, and 0.20, with 0.50 applying to the most recent
demand.
b. Calculate the MAD for each method.
Problem:

a.The simple moving average method and the weighted

moving average method give the following results:

Current Simple Moving Average Weighted Moving Average Forecast

Week Forecast for Next Week for Next Week
June 16 52 + 65 + 50
= 55.7 or 56 [(0.5  52) + (0.3  65) + (0.2  50)] = 55.5 or 56
3
56 + 52 + 65
June 23 = 57.7 or 58 [(0.5  56) + (0.3  52) + (0.2  65)] = 56.6 or 57
3
55 + 56 + 52
June 30 = 54.3 or 54 [(0.5  55) + (0.3  56) + (0.2  52)] = 54.7 or 55
3
60 + 55 + 56
= 57.0 or 57 [(0.5  60) + (0.3  55) + (0.2  56)] = 57.7 or 58
July 7 3
Problem:

b. The mean absolute deviation is calculated as follows:

Simple Moving Average Weighted Moving Average

Actual Forecast for Forecast for
Week Demand This Week Absolute Errors |Et| This Week Absolute Errors |Et|
June 23 56 56 |56 – 56| = 0 56 |56 – 56| = 0
June 30 55 58 |55 – 58| = 3 57 |55 – 57| = 2
July 7 60 54 |60 – 54| = 6 55 |60 – 55| = 5

0+3+6 0+2+2
MAD = =3 MAD = = 2.3
3 3

For this limited set of data, the weighted moving average

method resulted in a slightly lower mean absolute deviation.
However, final conclusions can be made only after analyzing
much more data.
Causal Methods: Linear Regression
• A dependent variable is related to one or more independent variables by a
linear equation.
• The independent variables are assumed to “cause” the results observed in
the past.
• Simple linear regression model is a straight line
Y = a + bX
where
Y = dependent variable
X = independent variable
a = Y-intercept of the line
b = slope of the line
Linear Regression

Y
Deviation, Regression
or error equation:
Estimate of Y = a + bX

Dependent variable
Y from
regression
equation
Actual
value
of Y

Value of X used
to estimate Y

X
Independent variable
QUESTIONS

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