Copperbelt University

School of Business
BS/BF 343- Production and Operations Management
Forecasting
 Overview of forecasting
• Forecasting is the prediction of future
events on the basis of either:
Historical data
Opinions
Trend of events, or
Known future variables
 Introduction forecasting
• Demand estimates for products and services are the
starting point for all the other planning.
• Management develop demand or sales forecasts
based on demand estimates.
• The sales forecasts become inputs to both business
strategy and production resource forecasts.
• To the operations manager, the primary goal is to
match supply to demand, and having forecast of
demand is essential to determining the capacity
needed to match demand
 Definition
• Forecasting is the art and science of
predicting future events. It may involve
taking historical data and projecting them
into the future with some sort of
mathematical model. It may be subjective
or intuitive prediction. Or it may involve
a combination of these-i.e. a
mathematical model adjusted by a
manager’s good judgement
 Key issues in forecasting
1. A forecast is only as good as the information
included in the forecast (past data)
2. History is not a perfect predictor of the future (i.e.:
there is no such thing as a perfect forecast)

REMEMBER: Forecasting is based on the assumption

that the past predicts the future! When forecasting,
think carefully whether or not the past is strongly
related to what you expect to see in the future…
 Forecasting in Business
• Forecasts provide information that assist managers in
guiding future activities toward organizational goals
• Forecasting is critical to management of all organizational
functional areas :
▪ Marketing-pricing and promotion, competition strategies
▪ Accounting-new product/process cost estimates, profit
projections, cost management
▪ Finance-equipment replacement needs, timing & amount
of funding, borrowing needs
▪ Human resources-hiring activities, training
▪ Operations-scheduling, capacity planning, workloads,
work assignment, inventory planning, etc
 General Characteristics of Forecasts
• Forecasts are seldom perfect
• The prediction does not take account of all
factors; The environment is complex and
subject to rapid change [STEEPLE FACTORS]
• Forecasts are more accurate for groups or
families of items
• Forecasts are more accurate for shorter time
periods; Long term forecasting is problematic
• Every forecast should include an error estimate
• STEEPLE is more advanced as it
deals with macro-environmental
external factors.
• It is an acronym for Social,
Technological, Economic,
Environmental, Political, Legal
and Ethical. These elements can
affect your business
Examples of Operations Resource Forecasts
Forecast Units of
Time Span Item Being Forecast
Horizon Measure
Facility location or expansion
Factory capacities
Kwacha, tons,
Long-Range 3+ years Planning for new products
etc.
Capital expenditures
R&D
Department capacities
Sales planning
Procurement/production planning
3 months to 3 Kwacha, tons,
Medium-Range and budgeting
years etc.
Cash budgeting
Product groups
Analysis of various operating plans
Specific product quantities
Machine capacities
Up to 1 year, Planning purchasing
Physical units of
Short-Range generally less Job scheduling
products
than 3 months Workforce levels
Production levels
Job assignments
 Distinguishing Differences
• Medium/Long range forecasts deal with more
comprehensive issues and support management
decisions regarding planning and products, plants
and processes
• Short-term forecasting usually employs different
methodologies than longer-term forecasting
• Short-term forecasts tends to be more accurate
than longer-term forecasts
 Types of Forecasts
• Economic forecasts
➢Address business cycle-inflation rate, money supply,
housing starts, etc
• Technological forecasts
➢Predicts rate of technological progress
➢Impacts development of new products
• Demand forecasts
➢Predict sales of existing product and services
 Elements of a Good Forecast
• The forecast should be timely
• The forecast should be accurate
• The forecast should be reliable
• The forecast should be expressed in
meaningful units
• The forecast should be in writing
• The forecasting technique should be simple to
understand and use
• The forecast should be cost-effective
 Steps in the Forecasting Process
1. Determine the purpose of the forecast (how it will used &
when it will be needed?)
2. Select the items to be forecasted (labour, product)
3. Establish a time horizon (indicate the time interval,
keeping in mind accuracy decreases with time).
4. Select the Forecasting Model (Qualitative technique or
Quantitative technique)
5. Gather data needed to make the forecast.
6. Generate the forecast
7. Monitor forecast accuracy over time
 Forecasting Methods
• Qualitative Approaches
• Quantitative Approaches
 Characteristics Of Forecasting Methods
Methods Data Required Relative Cost Forecast Horizon Application
Subjective:
models: Delphi Survey results High Long term Technological
forecasting
Cross-impact Correlations High Long term Technological
analysis between events forecasting
Historical Several years of High Medium to long Life cycle
analogy data for a similar term demand
situation projection
Causal models:
Regression All past data for Moderate Medium term Demand
all variables forecasting
Econometric All past data for Moderate to Medium to long Economic
all variables high term conditions
Time series models:
Moving average N most recent Very low Short term Demand
observations forecasting
Exponential Previous Very low Short term Demand
smoothing smoothed value forecasting
and most recent
observation
 Qualitative Approaches
 Used when there is lack of sufficient or appropriate
data.
 Usually based on judgments about causal factors that
underlie the demand of particular products or services
 Do not require a demand history for the product or
service, therefore are useful for new products/services
 Approaches vary in sophistication from scientifically
conducted surveys to intuitive hunches about future
events
 The approach/method that is appropriate depends on a
product’s life cycle stage
 Qualitative Methods
• Educated guess intuitive hunches
• Executive Opinions
• Delphi method
• Cross-Impact Analysis
• Historical Analogy
• Survey of sales force
• Survey of customers
• Market research scientific
 Executive opinions
• Executive opinion is a forecasting method in which a group
of managers meet and collectively develop a forecast.
• The Committee may use many inputs from all parts of the
organization.
• The method is often used for strategic forecasting or
forecasting the success of a new product or service.
• Sometimes it can be used to change an existing forecast to
account for unusual events, such as an unusual business
cycle or unexpected competition.
• Although managers can bring good insights to the forecast,
this method has a number of disadvantages. Often the
opinion of one person can dominate the forecast if that
person has more power than the other members of the group
or is very domineering.
Executive opinions
 Delphi Method
Made up of 3 types of participants: decision
makers, staff personnel and respondents.
Decision makers usually consist of a group 5 to 10
experts who will make the actual forecast
Staff personnel assist in preparing, distributing,
collecting & summarizing a series of questionnaire
& survey results from respondents.
 Respondents (experts) are groups of people located
in different places who judgement is valued.
Very expensive, time-consuming method and is
practical only for long-term forecasting.
 Cross-Impact Analysis
• Cross-impact analysis assumes that some future
event is related to the occurrence of an earlier
event.
• Like Delphi method , a panel of experts studies a
set of correlations between events presented in a
matrix.
• These correlations form the basis for estimating
the likelihood of a future event occurring
 Historical Analogy
• Historical analogy assumes that the introduction and
growth pattern of a new service will mimic the
pattern of a similar concept for which data are
available.
• Used frequently to forecast the market penetration
or life cycle of a new service.
• The concept of a product life cycle as used in
marketing involves stages, such as introduction,
growth, maturity, and decline.
 Survey of Sales Force
 Estimates of future regional sales are obtained from individual
members of the sales force.
 These estimates are combined to form an estimate of sales for all
regions.
 Managers must then transform this estimate into a sales forecast
to ensure realistic estimates.
 This is a popular forecasting method for companies that have a
good communication system in place and that have salespersons
who sell directly to customers.
 However, has drawback-sales fail to distinguish between what
customer would like and what they will actually will do, they are
influenced by recent past, conflict of interest if sales are used as
sales quotas.
 Survey of Customers
• Estimates of future sales are obtained directly
from customers on their future purchasing plan.
• Individual customers are surveyed to determine
what quantities of the firm’s products they intend
to purchase in each future time period.
• A sales forecast is determined by combining
individual customer’s responses.
• This method may be preferred by companies that
have relatively few customers.
 Market Research
• Market Research is the systematic
design, collection, analysis and
reporting of data and findings relevant
to a specific marketing situation facing
the organisation.
• Trying to identify customer habits;
new product ideas, consumer
behaviour etc.
Quantitative Forecasting Approaches
• Quantitative forecasting is based on the
assumption that the “forces” that generated
the past demand will generate the future
demand, i.e., history will tend to repeat
itself.
• Analysis of the past demand pattern provides
a good basis for forecasting future demand.
• Majority of quantitative approaches fall in
the category of time series analysis.
 Quantitative Approaches

1. Naive approach
2. Moving averages
time-series
3. Exponential models
smoothing
4. Trend projection
5. Linear regression associative
model

4 - 28
 Time Series Analysis

• A time series is a set of numbers where the

order or sequence of the numbers is
important, e.g., historical demand.
• Analysis of the time series identifies
patterns;
• Once the patterns are identified, they can be
used to develop a forecast.
 Components of Time Series
• Trends is long-term gradual upward or downward
movement of the data (T).
• Seasonality is a short-term data pattern that repeats
itself over a period (days, weeks, months, or quarters)
(S)
• Cycle is a wavelike data pattern that repeats itself
lasting more than one year (C).
• Irregular variations are jumps in the level of the
series caused by unusual circumstances, not
reflective of typical behaviour.
• Random variations are“blips” in the data caused by
chance & unusual situations (R).
What should we consider when looking at
past demand data?

• Trends

• Seasonality

• Cyclical elements

• Autocorrelation

• Random variation
 Components of Demand
Trend
component
Demand for product or service

Seasonal peaks

Actual demand
line

Average demand
over 4 years

Random variation
| | | |
1 2 3 4
Time (years)

4 - 32
 Seasonal Patterns

Length of Time Number of

Before Pattern Length of Seasons
Is Repeated Season in Pattern
Year Quarter 4
Year Month 12
Year Week 52
Month Day 28-31
Week Day 7
Short-Range Forecasting Methods

• (Simple) Moving Average

• Weighted Moving Average
• Exponential Smoothing (exponentially
weighted moving average)
 Naïve Approach
• This is the simplest way to forecast.
• Demand for the next period will be equal to the
demand in the most recent period.
• For example, January sales Zamtel Phones is 700
so the sales for February will be 700.
• Does this make sense?
• How about demand for mealie meal?
• For some products this is the most cost-effective
method.
• It provides a starting point for sophisticated
models
 Moving Averages (MA)

• A MA uses a number of historical actual data to

generate forecasts.
• Key Assumption: Market demands will stay
fairly steady over time.
 Simple Moving Average

• An averaging period (AP) is given or selected

• The forecast for the next period is the arithmetic
average of the AP most recent actual demands
• It is called a “simple” average because each period
used to compute the average is equally weighted
 Simple Moving Average

• It is called “moving” because as new demand

data becomes available, the oldest data is not
used
• By increasing the AP, the forecast is less
responsive to fluctuations in demand (low
impulse response and high noise dampening)
• By decreasing the AP, the forecast is more
responsive to fluctuations in demand (high
impulse response and low noise dampening)
 Moving Average Example
Actual 3-Month
Month Shed Sales Moving Average

January 10 10
February 12 12
March 13 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3

© 2011 Pearson Education, Inc. publishing as Prentice Hall

 Weighted Moving Average
• This is a variation on the simple moving
average where the weights used to compute
the average are not equal.
• This allows more recent demand data to
have a greater effect on the moving
average, therefore the forecast.
• . . . more
 Weighted Moving Average

• The weights must add to 1.0 or 10 or

100% and generally decrease in value
with the age of the data.
• The distribution of the weights determine
the impulse response of the forecast.
 Weighted Moving Average
▪ Used when some trend might be present
▪ Older data usually less important
▪ Weights based on experience and
intuition

Weighted ∑ (weight for period n) x (demand in period n)

moving = ∑ weights
average

© 2011 Pearson Education, Inc. publishing as Prentice Hall

 Weighted Moving Average
Weights Applied Period
3 Last month
2 Two months ago
1 Three months ago
6 Sum of weights

Actual 3-Month Weighted

Month Shed Sales Moving Average
January 10 10
February 12 12
March 13 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2
© 2011 Pearson Education, Inc. publishing as Prentice Hall
 Potential Problems With
Moving Average
◆Increasing n smooths the forecast but
makes it less sensitive to real changes in
the data
◆Do not forecast trends well because
they are averages, they will always stay
within past levels and will not predict
changes to either higher or lower levels.
◆Require extensive historical data
© 2011 Pearson Education, Inc. publishing as Prentice Hall
©
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 Exponential Smoothing

▪ Form of weighted moving average

▪ Weights decline exponentially
▪ Most recent data weighted most
▪ Requires smoothing constant ()
▪ Ranges from 0 to 1
▪ Subjectively chosen
▪ Involves little record keeping of past data

© 2011 Pearson Education, Inc. publishing as Prentice Hall

 Exponential Smoothing
New forecast = Last period’s forecast
+  (Last period’s actual demand
– Last period’s forecast)

Ft = Ft – 1 +  (At – 1 - Ft – 1)

Where Ft = new forecast

Ft – 1 = previous forecast
 = smoothing (or weighting)
constant (0 ≤  ≤ 1)
At – 1 = previous period’s actual demand

© 2011 Pearson Education, Inc. publishing as Prentice Hall

 Impact of Different 
225 –

Actual  = .5
200 – demand
Demand

175 –

 = .1
150 – | | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter

© 2011 Pearson Education, Inc. publishing as Prentice Hall

 Exponential Smoothing
• The smoothing constant, , must be between 0.0 and
1.0.
• For business applications, , range from 0.05 to 0.5
• A large  provides a high impulse response forecast
(more sensitive)
• When  = to 1 then Ft = 1.0 At – 1 , it becomes
naïve model
• A small  provides a low impulse response forecast.
 Impact of Different 
225 –

Actual  = .5
◆200
Chose
– high values
demandof 
Demand

when underlying average

is likely to change
–
◆175
Choose low values of 
when underlying average  = .1
is stable|
150 – | | | | | | | |
1 2 3 4 5 6 7 8 9
Quarter

© 2011 Pearson Education, Inc. publishing as Prentice Hall

 Choosing 
The objective is to obtain the most accurate
forecast no matter the technique
We generally do this by selecting the model that gives
us the lowest forecast error
Forecast error = Actual demand - Forecast value
= At – Ft

• High  is chosen when underlying average is

likely to change
• Low values  chosen when underlying average
is fairly stable
© 2011 Pearson Education, Inc. publishing as Prentice Hall
 Example: Central Call Centre
 Moving Average:
 CCC wishes to forecast the number of incoming calls it
receives in a day from the customers of one of its
clients, BMI. CCC schedules the appropriate number
of telephone operators based on projected call
volumes.
 CCC believes that the most recent 12 days of call
volumes (shown on the next slide) are representative of
the near future call volumes.
 Example: Central Call Centre
• Moving Average
– Representative Historical Data

Day Calls Day Calls

1 159 7 203
2 217 8 195
3 186 9 188
4 161 10 168
5 173 11 198
6 157 12 159
 Example: Central Call Centre

• Moving Average
Use the moving average method with an AP = 3
days to develop a forecast of the call volume in Day
13.
F13 = (168 + 198 + 159)/3 = 175.0 calls
 Example: Central Call Centre
Weighted Moving Average
Use the weighted moving average method with an
AP = 3 days and weights of 0.1 (for oldest datum),
0.3, and 0.6 to develop a forecast of the call volume
in Day 13.
F13 = 0.1(168) + 0.3(198) + 0.6(159) = 171.6 calls
Note: The WMA forecast is lower than the MA
forecast because Day 12’s relatively low call
volume carries almost twice as much weight in the
WMA (0.60) as it does in the MA (0.33).
 Example: Central Call Centre
Exponential Smoothing
If a smoothing constant value of 0.25 is used and the
exponential smoothing forecast for Day 11 was 180.76 calls,
what is the exponential smoothing forecast for Day 13?
F12 = 180.76 + 0.25(198 – 180.76) = 185.07
F13 = 185.07 + 0.25(159 – 185.07) = 178.55
 Evaluating Forecast-Model Performance
• Accuracy
– Accuracy is the typical criterion for judging the
performance of a forecasting approach
– Accuracy is how well the forecasted values match the
actual values
 Monitoring Accuracy

• Accuracy of a forecasting approach needs to be

monitored to assess the confidence you can have in
its forecasts and changes in the market may require
reevaluation of the approach
• Accuracy can be measured in several ways
– Standard error of the forecast (covered earlier)
(Actual value-Forecast value)
– Mean absolute deviation (MAD)
– Mean squared error (MSE)
– Mean absolute percent error (MAPE)
 Common Measures of Error
Mean Absolute Deviation (MAD)

∑ |Actual - Forecast|
MAD =
n

Mean Squared Error (MSE)

∑ (Forecast Errors)2
MSE =
n

Mean Absolute Percent Error (MAPE)

∑ |Actual - Forecast|
X 100
Actual
MAPE =
n
© 2011 Pearson Education, Inc. publishing as Prentice Hall
 Example: Central Call Centre

• Forecast Accuracy – MAD and MSE and MAPE

Which forecasting method (the AP = 3 moving
average or the  = 0.25 exponential smoothing) is
preferred, based on the MAD over the most recent 9
days? (Assume that the exponential smoothing
forecast for Day 3 is the same as the actual call
volume.)
 Example: Central Call Centre

• Moving Average
– Representative Historical Data

Day Calls Day Calls

1 159 7 203
2 217 8 195
3 186 9 188
4 161 10 168
5 173 11 198
6 157 12 159
Mean absolute deviation (MAD)
AP = 3  = .25
Day Calls Forec. |Error| Forec. |Error|
4 161 187.3 26.3 186.0 25.0
5 173 188.0 15.0 179.8 6.8
6 157 173.3 16.3 178.1 21.1
7 203 163.7 39.3 172.8 30.2
8 195 177.7 17.3 180.4 14.6
9 188 185.0 3.0 184.0 4.0
10 168 195.3 27.3 185.0 17.0
11 198 183.7 14.3 180.8 17.2
12 159 184.7 25.7 185.1 26.1
MAD 20.5 18.0
 Mean squared error (MSE)
AP = 3 a = .25
Day Calls Forec. |Error| (|Error|)2 Forec. |Error| (|Error|)2
4 161 187.3 26.3 691.69 186 25 625
5 173 188 15 225 179.8 6.8 46.24
6 157 173.3 16.3 265.69 178.1 21.1 445.21
7 203 163.7 39.3 1544.49 172.8 30.2 912.04
8 195 177.7 17.3 299.29 180.4 14.6 213.16
9 188 185 3 9 184 4 16
10 168 195.3 27.3 745.29 185 17 289
11 198 183.7 14.3 204.49 180.8 17.2 295.84
12 159 184.7 25.7 660.49 185.1 26.1 681.21
4645.4 3523.7
MSE 516.2 391.5
Mean absolute percent error (MAPE)
AP = 3  = .25
|Error|/Actual |Error|/Actual
Day Calls Forec. |Error| *100 Forec. |Error| *100
4 161 187.3 26.3 16.3 186 25 15.5
5 173 188 15 8.7 179.8 6.8 3.9
6 157 173.3 16.3 10.4 178.1 21.1 13.4
7 203 163.7 39.3 19.4 172.8 30.2 14.9
8 195 177.7 17.3 8.9 180.4 14.6 7.5
9 188 185 3 1.6 184 4 2.1
10 168 195.3 27.3 16.3 185 17 10.1
11 198 183.7 14.3 7.2 180.8 17.2 8.7
12 159 184.7 25.7 16.2 185.1 26.1 16.4
104.9 92.6
MAPE 11.7 10.3
 Long-Range Forecasts
• Time spans usually greater than three year.
• Necessary to support strategic decisions
about planning products, processes, and
facilities.
 Simple Linear Regression
• Linear regression analysis establishes a
relationship between a dependent variable
and one or more independent variables.
• In simple linear regression analysis there is
only one independent variable.
• If the data is a time series, the independent
variable is the time period.
• The dependent variable is whatever we wish
to forecast.
Variable Definitions and Formulas for Simple Linear
Regression
 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

y^ = a + bx
^ = computed value of the variable to
where y
be predicted (dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable

4 - 68
 Values of Dependent Variable Least Squares Method

Actual observation Deviation7

(y-value)

Deviation5 Deviation6

Deviation3

Deviation4

Deviation1
(error) Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

© 2011 Pearson Education, Inc. publishing as Prentice Hall 4 - 69
Values of Dependent Variable Least Squares Method

Actual observation Deviation7

(y-value)

Deviation5 Deviation6

Deviation3 Least squares method

minimizes the sum of the
Deviation
squared errors (deviations)
4

Deviation1
(error) Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

4 - 70
 Developing a Linear Regression Equation
• Step 1: Collect the historical data required for
• analysis.
• Step 2: Identify the X and Y values for each
• observation.
• Step 3: Put the data in tabular form and make
• necessary column calculations.
• Step 4: Compute the Y intercept (a) and the
• slope (b) using least squares regression
• equations.
• Step 5: Formulate the estimating equation.
 Example: College Enrollment
 Simple Linear Regression
At a small regional college enrollments have
grown steadily over the past six years, as
evidenced below. Use time series regression to
forecast the student enrollments for the next
three years.
Students Students
Year Enrolled (1000s) Year Enrolled
(1000s)
1 2.5 4 3.2
2 2.8 5 3.3
3 2.9 6 3.4
 Example: College Enrollment
• Simple Linear Regression
x y x2 xy
1 2.5 1 2.5
2 2.8 4 5.6
3 2.9 9 8.7
4 3.2 16 12.8
5 3.3 25 16.5
6 3.4 36 20.4

Sx=21 Sy=18.1 Sx2=91 Sxy=66.5

 Example: College Enrollment

• Y=2.387+0.18X
• Simple Linear Regression
Y7 = 2.387 + 0.180(7) = 3.65 or 3,650 students
Y8 = 2.387 + 0.180(8) = 3.83 or 3,830 students
Y9 = 2.387 + 0.180(9) = 4.01 or 4,010 students

Note: Enrollment is expected to increase by 180

students per year.
 Simple Linear Regression

• Simple linear regression can also be used

when the independent variable X represents
a variable other than time.
• In this case, linear regression is
representative of a class of forecasting
models called causal forecasting models.
 Example: Railroad Products Co.
 Simple Linear Regression – Causal Model
The manager of RPC wants to project the
firm’s sales for the next 3 years. He knows that
RPC’s long-range sales are tied very closely to
national freight car loadings. On the next slide
are 7 years of relevant historical data.
Develop a simple linear regression model
between RPC sales and national freight car
loadings. Forecast RPC sales for the next 3 years,
given that the rail industry estimates car loadings
of 250, 270, and 300 million.
Example: Railroad Products Co.
• Simple Linear Regression – Causal Model
RPC Sales Car Loadings
Year (K millions) (K millions)
1 9.5 120
2 11.0 135
3 12.0 130
4 12.5 150
5 14.0 170
6 16.0 190
7 18.0 220
Example: Railroad Products Co.
 Simple Linear Regression – Causal Model
x y x2 xy
120 9.5 14,400 1,140
135 11.0 18,225 1,485
130 12.0 16,900 1,560
150 12.5 22,500 1,875
170 14.0 28,900 2,380
190 16.0 36,100 3,040
220 18.0 48,400 3,960
1,115 93.0 185,425 15,440
Example: Railroad Products Co.

Simple Linear Regression – Causal Model

Y8 = 0.528 + 0.0801(250) = K20.55 million
Y9 = 0.528 + 0.0801(270) = K22.16 million
Y10 = 0.528 + 0.0801(300) = K 24.56 million

Note: RPC sales are expected to increase by KR

80,100 for each additional million national freight
car loadings.
 Multiple Regression-Example
Multiple regression analysis is used when there are
two or more independent variables.
An example of a multiple regression equation is:
Y = 50.0 + 0.05X1 + 0.10X2 – 0.03X3
where: Y = firm’s annual sales (K-millions)
X1 = industry sales (K-millions)
X2 = regional per capita income (K-
thousands)
X3 = regional per capita debt (K-thousands)
 Coefficient of Correlation (r)
• The coefficient of correlation, r, explains the
relative importance of the relationship
between x and y.
• The sign of r shows the direction of the
relationship.
• The absolute value of r shows the strength of
the relationship.
• The sign of r is always the same as the sign
of b.
• r can take on any value between –1 and +1.
 Coefficient of Correlation (r)
• Meanings of several values of r:
-1 a perfect negative relationship (as x goes up, y
goes down by one unit, and vice versa)
+1 a perfect positive relationship (as x goes up, y
goes up by one unit, and vice versa)
0 no relationship exists between x and y
+0.3 a weak positive relationship
-0.8 a strong negative relationship
 Coefficient of Correlation (r)
r is computed by:

Were:
x = independent variable values
y = dependent variable values
n = number of observations
 Coefficient of Determination (r2)
• Although the coefficient of correlation is helpful in
measuring the relationship between X and Y;
• terms such as strong, moderate and weak are not very
specific measures of relationship.
• The coefficient of determination, r2, is the square of the
coefficient of correlation.
• The modification of r to r2 allows us to shift from
subjective measures of relationship to a more specific
measure.
Example: Railroad Products Co.
Coefficient of Correlation
x y x2 xy y2
120 9.5 14,400 1,140 90.25
135 11.0 18,225 1,485 121.00
130 12.0 16,900 1,560 144.00
150 12.5 22,500 1,875 156.25
170 14.0 28,900 2,380 196.00
190 16.0 36,100 3,040 256.00
220 18.0 48,400 3,960 324.00
1,115 93.0 185,42515,440 1,287.50
Example: Railroad Products Co.

Coefficient of Determination
r2 = (.9829)2 = .966
96.6% of the variation in RPC sales is
explained by national freight car loadings.
 Seasonalised Time Series
Regression Analysis
• Select a representative historical data set.
• Develop a seasonal index for each season.
• Use the seasonal indexes to deseasonalize the data.
• Perform linear regression analysis on the
deseasonalized data.
• Use the regression equation to compute the
forecasts.
• Use the seasonal indexes to reapply the seasonal
patterns to the forecasts.
Example: Computer Products Corp.

• Seasonalised Times Series Regression

Analysis
• An analyst at CPC wants to develop next
year’s quarterly forecasts of sales revenue
for CPC’s line of Epsilon Computers. She
believes that the most recent 8 quarters of
sales (shown on the next slide) are
representative of next year’s sales.
Example: Computer Products Corp.

• Seasonalised Times Series Regression

Analysis
– Representative Historical Data Set
Year Qtr. (K m.) Year Qtr. (K m.)
1 1 7.4 2 1 8.3
1 2 6.5 2 2 7.4
1 3 4.9 2 3 5.4
1 4 16.1 2 4 18.0
 Example: Computer Products Corp.
Seasonalised Times Series Regression Analysis
– Compute the Seasonal Indexes

Quarterly Sales
Year Q1 Q2 Q3 Q4 Total
1 7.4 6.5 4.9 16.1 34.9
2 8.3 7.4 5.4 18.0 39.1
Totals 15.7 13.9 10.3 34.1 74.0
Qtr. Avg. 7.85 6.95 5.15 17.05 9.25
Seasonal Index 0.849 0.751 0.557 1.843 4.000

*Overall quarter average = 74/8 = 9.25

**S.I = Quarter average/Overall quarter average
=7.85/9.25=0.849
 Example: Computer Products Corp.
• Seasonalised Times Series Regression Analysis
– Deseasonalize the Data
Quarterly Sales
Year Q1 Q2 Q3 Q4
1 8.72 8.66 8.80 8.74
2 9.78 9.85 9.69 9.77

**Deseasonalised data=sales figures/seasonalised index

=7.4/0.849 = 8.72
 Example: Computer Products Corp.
• Seasonalised Times Series Regression
Analysis
– Perform Regression on Deseasonalised Data
Yr. Qtr. x y x2 xy
1 1 1 8.72 1 8.72
1 2 2 8.66 4 17.32
1 3 3 8.80 9 26.40
1 4 4 8.74 16 34.96
2 1 5 9.78 25 48.90
2 2 6 9.85 36 59.10
2 3 7 9.69 49 67.83
2 4 8 9.77 64 78.16
Totals 36 74.01 204 341.39
Example: Computer Products Corp.
• Seasonalised Times Series Regression Analysis
– Compute the Deseasonalised Forecasts
Y=8.357+0.199X
Y9 = 8.357 + 0.199(9) = 10.148
Y10 = 8.357 + 0.199(10) = 10.347
Y11 = 8.357 + 0.199(11) = 10.546
Y12 = 8.357 + 0.199(12) = 10.745

Note: Average sales are expected to increase by

.199 million (about $200,000) per quarter.
 Example:
Computer Products Corp.
• Seasonalised Times Series Regression Analysis
– Seasonalise the Forecasts
Seas. Deseases. Seas.
Yr. Qtr. Index Forecast Forecasts
3 1 0.849 10.148 8.62
3 2 0.751 10.347 7.77
3 3 0.557 10.546 5.87
3 4 1.843 10.745 19.80

**Seasonalised forecast=deseasesonalised forecast x seasonalised index

 Forecasting in the Service
Sector
◆ Presents unusual challenges
◆ Special need for short term records
◆ Needs differ greatly as function of
industry and product
◆ Holidays and other calendar events
◆ Unusual events

© 2011 Pearson Education, Inc. publishing as Prentice Hall 4 - 96

 Criteria for Selecting
a Forecasting Method

• Cost
• Accuracy
• Data available
• Time span
• Nature of products and services
• Impulse response and noise dampening
Criteria for Selecting a Forecasting Method
• Cost and Accuracy
– There is a trade-off between cost and accuracy;
generally, more forecast accuracy can be obtained
at a cost.
– High-accuracy approaches have disadvantages:
• Use more data
• Data are ordinarily more difficult to obtain
• The models are more costly to design, implement, and
operate
• Take longer to use
Criteria for Selecting a Forecasting Method

• Cost and Accuracy

–Low/Moderate-Cost Approaches –
statistical models, historical analogies,
executive-committee consensus
–High-Cost Approaches – complex
econometric models, Delphi, and
market research
Criteria for Selecting a Forecasting Method
• Data Available:
– Is the necessary data available or can it be
economically obtained?
– If the need is to forecast sales of a new
product, then a customer survey may not be
practical; instead, historical analogy or
market research may have to be used.
Criteria for Selecting a Forecasting Method
• Time Span
– What operations resource is being forecast and
for what purpose?
– Short-term staffing needs might best be forecast
with moving average or exponential smoothing
models.
– Long-term factory capacity needs might best be
predicted with regression or executive-committee
consensus methods.
Criteria for Selecting a Forecasting Method

• Nature of Products and Services

– Is the product/service high cost or high
volume?
– Where is the product/service in its life
cycle?
– Does the product/service have seasonal
demand fluctuations?
Criteria for Selecting a Forecasting Method

• Impulse Response and Noise Dampening:

– An appropriate balance must be achieved
between:
• How responsive we want the forecasting model
to be to changes in the actual demand data
• Our desire to suppress undesirable chance
variation or noise in the demand data
 Reasons for Ineffective Forecasting
• Not involving a broad cross section of people
• Not recognizing that forecasting is integral to
business planning
• Not recognizing that forecasts will always be
wrong
• Not forecasting the right things
• Not selecting an appropriate forecasting method
• Not tracking the accuracy of the forecasting
models
 Forecasting in Small Businesses
and Start-Up Ventures
• Forecasting for these businesses can be
difficult for the following reasons:
– Not enough personnel with the time to forecast
– Personnel lack the necessary skills to develop
good forecasts
– Such businesses are not data-rich environments
– Forecasting for new products/services is always
difficult, even for the experienced forecaster
??? - - ✓✓✓

End of Unit