topic 6 - forecasting
TRANSCRIPT
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OperationsManagement
Forecasting
Prof. Upendra Kachru
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Prediction Prediction
Reflects judgment after taking all
considerations into account
Involves anticipated changes in
future that may or may not happen
Based on intuition
It can be biasedNo error analysis
Based on unique representations
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Forecasting
Forecasting
Involves the projection of the pastinto the future
Estimating the demand on the basis
of factors that generated thedemand
Based on theoretical model
It is objective
Error Analysis is possible
Results are replicable
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A forecast is an estimate of
a future event achieved by
systematically combiningand casting forward , in a
predetermined way, data
about the past.
DEFININGFORECASTING
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Forecasting vs. Prediction
Forecasting Prediction
Involves the projection of the past intothe future
Reflects managements judgment aftertaking all considerations into account
Estimating the demand on the basis of
factors that generated the demand
Involves anticipated changes in future
that may or may not generate thedemand
Based on theoretical model Based on intuition
It is objective It can be biased
Error Analysis is possible No error analysis
Results are replicable Based on unique representations
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Forecasting is the start
of any planning activity.
The main purpose of
forecasting is to estimatethe occurrence, timing or
magnitude of future
events.
WHYFORECASTING?
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The Decision making Cycle
Forecasts help management take into account external
factors that impact operations and reduce the uncertainty.
The decision making cycle reflects how organizations use
forecasting to reduce the impact of market forces on abusiness.
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Decision Types requiring Forecasting
Forecasting horizon in years
Specific demand
Aggregate
demand
Strategies &
facilities
Types of Decision
Short term
Long term
Planning
Medium
term
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Demand Forecasting
Demand Forecasting is theactivity of estimating the quantityof a product or service that
consumers will purchase.
Demand forecasting involvestechniques including both formal
and informal methods.
Demand forecasting may be used
in making scheduling decisions, in
assessing future capacity
requirements, or in making
decisions on whether to enter
a new market.
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A
B(4) C(2)
D(2) E(1) D(3) F(2)
Dependent Demand:
Raw Materials,
Component parts,
Sub-assemblies, etc.
Independent Demand:
Finished Goods
Types of Demand
Aggregate Planning is concerned with aggregate demandi.e. the amount of a particular economic goodor service that a consumer or group of consumers
will want to purchase (at a given price).
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The firm should be able toforecast ideal levels of
inventory.The relative cost of holdingeither too much or too littleinventory might be differentfrom the ideal levels because
of poor forecasts of demand. If demand were less than
expected, the firm would incurextra inventories and the cost ofholding them.
If demand were greater than
expected, the firm would incurback-order or shortage cost andthe possible opportunity costs oflost sales or a lower volume ofactivity.
Demand and Costs
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Demand Management
Do I manage demand ?
Do I live with it?
Demand management describes the process ofinfluencing the volume of consumption of the
product or service through management decision
so that firms can use their resources and
production capacity more effectively.
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Can take an active role toinfluence demand. For example,air conditioner manufacturesoffer discounts for theirproducts in winter , when
demand for the products falls. Demand management is also
used to spread demand moreevenly. Telephone companies,world over, offer discounts for
calls made during late hours orat night.
Can take a passive role andsimply respond to demand
Independent Demand
What to do?
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Eight Steps toEight Steps to
ForecastingForecasting
Determining the use of theDetermining the use of theforecast--what are theforecast--what are the
objectives?objectives?
Select the items to be forecastSelect the items to be forecast
Determine the time horizon ofDetermine the time horizon ofthe forecastthe forecast
Select the forecasting model(s)Select the forecasting model(s)
Collect the dataCollect the data
Validate the forecasting modelValidate the forecasting model Make the forecastMake the forecast
Implement the resultsImplement the results
Prof. Upendra KachruProf. Upendra Kachru
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15
Quantitative
Time Series Analysis Exponential Method
Regression Analysis
Simulation/ Scenario PlanningQualitative (Judgmental)
Types of Forecasts
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Time Series1. Extrapolation
2. Moving average Method
Exponential Method
1. Simple Exponential Method2. Double Exponential Method
3. Triple Exponential Method
Regression Analysis
1. Simple Regression Analysis2. Multiple Regression Analysis
QuantitativeApproach
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Time Series
There are five basic patterns in which demand varieswith time that have been identified:
Horizontal Trend
Seasonal Cyclical Random
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Graphical Representation
Time
Demand(units)
Constant
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Moving Average Method
Where:
Ft+1
is the moving average for the period t+1,
At, A
t-1, A
t-2, A
t-3etc. are actual values for the corresponding
period, and n is the total number of periods in theaverage
Or it can be written as:
F =A + A + A +...+A
nt
t-1 t-2 t-3 t-n
The general formula for moving average is:
Ft+1 = (At + At-1 + At-2 + At-3 +
+ At-n+1 ) / n
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Simple Moving Average Problem
Week Demand
1 650
2 678
3 7204 785
5 859
6 920
7 850
8 7589 892
10 920
11 789
12 844
F = A + A + A +...+An
t t-1 t-2 t-3 t-n
Question: What are the 3-week and 6-week movingaverage forecasts fordemand?
Assuming you only have 3weeks and 6 weeks of actualdemand data for therespective forecasts
Question: What are the 3-week and 6-week moving
average forecasts fordemand?
Assuming you only have 3weeks and 6 weeks of actual
demand data for therespective forecasts
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Week Demand 3-Week 6-Week
1 650
2 678
3 720
4 785 682.67
5 859 727.676 920 788.00
7 850 854.67 768.67
8 758 876.33 802.00
9 892 842.67 815.3310 920 833.33 844.00
11 789 856.67 866.50
12 844 867.00 854.83
F4=(650+678+720)/3
=682.67F7=(650+678+720
+785+859+920)/6
=768.67
Calculating the moving averages gives us:
The McGraw-Hill Companies, Inc.,
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Problem (2) Data
Week Demand1 820
2 775
3 680
4 655
5 620
6 600
7 575
Question: What is the 3week moving average
forecast for this data?Assume you only have 3weeks and 5 weeks ofactual demand data for the
respective forecasts
Question: What is the 3week moving average
forecast for this data?Assume you only have 3weeks and 5 weeks ofactual demand data for therespective forecasts
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Problem (2) Solution
Week Demand 3-Week 5-Week
1 820
2 7753 680
4 655 758.33
5 620 703.33
6 600 651.67 710.00
7 575 625.00 666.00
F4=(820+775+680)/3
=758.33F6=(820+775+680
+655+620)/5
=710.00
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Weighted Moving Average
While the moving average formula implies an equal weightbeing placed on each value that is being averaged, the
weighted moving average permits an unequal weighting on
prior time periods
While the moving average formula implies an equal weight
being placed on each value that is being averaged, the
weighted moving average permits an unequal weighting on
prior time periods
The general formula for the weighted moving average then
changes to:
Ft+1 = wtAt + wt-1 At-1 + wt-2 At-2 + wt-3 At-3 +
+ wt-n+1 At-n+1Where:
Ft+1 is the weighted moving average for the period t+1,wt is the weighing factor, and wt = 1
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Weights:
t-1 .5
t-2 .3
t-3 .2
Week Demand
1 650
2 678
3 720
4
Question: Given the weekly demand and weights,what is the forecast for the 4th period or Week 4?
Question: Given the weekly demand and weights,
what is the forecast for the 4th period or Week 4?
Note that the weights place more emphasis onthe most recent data, that is time period t-1
Note that the weights place more emphasis onthe most recent data, that is time period t-1
F = w A + w A + w A +...+w At 1 t-1 2 t-2 3 t-3 n t-n
w = 1ii=1
n
wt = weight given to time period toccurrence (weights must add to one)
wt = weight given to time period toccurrence (weights must add to one)
The formula for the moving average can also be written as:The formula for the moving average can also be written as:
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Problem Solution
Week Demand Forecast
1 650
2 678
3 720
4 693.4
F4 = 0.5(720)+0.3(678)+0.2(650)=693.4
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Problem (2) Data
Weights:
t-1 .7
t-2 .2t-3 .1
Week Demand
1 820
2 775
3 680
4 655
Question: Given the weekly demand informationand weights, what is the weighted movingaverage forecast of the 5th period or week?
Question: Given the weekly demand informationand weights, what is the weighted movingaverage forecast of the 5th period or week?
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Problem (2) Solution
Week Demand Forecast
1 820
2 7753 680
4 655
5 672
F5 = (0.1)(755)+(0.2)(680)+(0.7)(655)= 672
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Exponential method is atechnique that is applied to time
series data, either to producesmoothed data for presentation,
or to make forecasts.
Premise: The most recent
observations might have thehighest predictive value.Therefore, we should give moreweight to the more recent timeperiods when forecasting
ExponentialMethod
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Exponential Smoothing Model
The exponential relationship be written as:
Ft+1 = Dt + (1 - ) FtWhere:
Dtis the actual value
Ftis the forecasted value
is the weighting factor, which ranges from 0 to 1
t is the current time period.
The variance is given by:
(Dt - Ft+1 )2/n = Variance
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Problem (1) Data
Week Demand
1 820
2 775
3 6804 655
5 750
6 802
7 7988 689
9 775
10
Question: Given the weeklydemand data, what are theexponential smoothing forecastsfor periods 2-10 using =0.10and =0.60?Assume F1=D1
Which is a better choice?
Question: Given the weeklydemand data, what are theexponential smoothing forecastsfor periods 2-10 using =0.10
and =0.60?Assume F1=D1
Which is a better choice?
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Week Demand 0.1 0.6
1 820 820.00 820.00
2 775 820.00 820.00
3 680 815.50 793.00
4 655 801.95 725.205 750 787.26 683.08
6 802 783.53 723.23
7 798 785.38 770.49
8 689 786.64 787.00
9 775 776.88 728.20
10 776.69 756.28
Answer: The respective alphas columns denote the forecastvalues. Note that you can only forecast one time period into thefuture.
Answer: The respective alphas columns denote the forecastvalues. Note that you can only forecast one time period into thefuture.
F3=775x0.1 + (1-0.1)x820 =815.50
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Answer: Variance0.3 = 6675.61 and Variance0.6 = 5369.39. Thereforealpha as 0.6 is a better choice
Answer: Variance0.3 = 6675.61 and Variance0.6 = 5369.39. Thereforealpha as 0.6 is a better choice
Demand 0.1 D-W (D-W)2 0.6 D-W (D-W)2
820 820.00 0.00 0.00 820.00 0.00 0775 820.00 -45.00 2025.00 820.00 -45.00 2025
680 815.50 -135.50 18360.25 793.00 -113.00 12769
655 801.95 -146.95 21594.30 725.20 -70.20 4928.04
750 787.26 -37.26 1387.94 683.08 66.92 4478.286
802 783.53 18.47 341.16 723.23 78.77 6204.398
798 785.38 12.62 159.35 770.49 27.51 756.6461
689 786.64 -97.64 9533.35 787.00 -98.00 9603.436
775 776.88 -1.88 3.52 728.20 46.80 2190.348
53404.87 42955.15
Which one?
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Plotting the Solution
5 0 0
6 0 0
7 0 0
8 0 0
9 0 0
1 2 3 4 5 6 7 8 9 1 0
W e e
Demand
D e m a
0 . 1
0 . 6
Note how that the smaller alpha results in a smootherline in this exampleNote how that the smaller alpha results in a smootherline in this example
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Problem (2) Data
Question: What are theexponential smoothingforecasts for periods 2-5using a =0.5?
Assume F1=D1
Question: What are theexponential smoothing
forecasts for periods 2-5using a =0.5?
Assume F1=D1
Week Demand
1 8202 775
3 680
4 6555
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Problem (2) Solution
Week Demand 0.5
1 820 820.00
2 775 820.00
3 680 797.50
4 655 738.75
5 696.88
F1=820x0.5 + (1.0-0.5)x820 =
820F3=775x0.5 + (1.0-0.5)x820
=797.75
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Exponential Smoothing & SimpleMoving Average
An exponentially weighted moving average with
a smoothing constant a, corresponds roughly toa simple moving average of length (i.e., period)
n, where and n are related by:
= 2/(n+1) OR n = (2 - )/ .
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Double and Triple Smoothing
An exponential smoothing over an alreadysmoothed time series is called double-exponential smoothing. It applies the process ofexponential smoothing to a time series that is
already exponentially smoothened.This is used when trends are not stationary.
In the case of nonlinear trends it might benecessary to extend it even to a triple-exponential smoothing. Triple ExponentialSmoothing is better at handling parabola trendsand is normally used for such data.
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Double Exponential Smoothing
What happens when there is a definitenon-stationary trend?
A trendy clothing boutique has had the following salesover the past 6 months:
1 2 3 4 5 6510 512 528 530 542 552
48 0
49 0
50 0
51 0
52 0
53 0
54 0
55 0
56 0
1 2 3 4 5 6 7 8 9 10
Month
Demand
Actual
Forecast
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Deseasoning Demand: Seasonal Index
Seasonal index represents the extent of seasonalinfluence for a particular segment of the year. Thecalculation involves a comparison of the expectedvalues of that period to the grand mean.The formula for computing seasonal factors is:
Si = Di/D,where:
Si = the seasonal index for i th period,
Di= the average values of i th period,
D = grand average,
i = the ith seasonal period of the cycle
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Regression Analysis is a
method of predicting the value
of one variable based on the
value of other variables.
It reflects the casual
relationship underlying the
demand being forecast and an
independent variable.
RegressionAnalysis
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Regression analysis is of two
types:
(a)Simple Linear Regression: A
regression using only one predictor iscalled a simple regression, and
(b)Multiple Regressions: Where thereare two or more predictors, multiple
regression analysis is employed.
There are two types of variables,
one that is being forecasted and
one from which the forecast is
made.
The first one is known as thedependent variable, the latter asthe independent variable.
RegressionAnalysis
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Where:
yt is the dependent variable
a is the Y interceptb is the slope of the line, and
x is the time period
Simple Regression Analysis
The functional relationship between the two canbe visualized within a system of coordinates
where the dependent variable is shown on the y
and independent variable on the x-axis.
yt=f(x) or yt = a + bx
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yt = a + bx
0 1 2 3 4 5 x (Time)
Y
The simple linear regression
model seeks to fit a linethrough various data over
time
The simple linear regression
model seeks to fit a linethrough various data over
time
Is the linear regression modelIs the linear regression model
a
Yt is the regressed forecast value or dependent variable inthe model, a is the intercept value of the the regression
line, and b is similar to the slope of the regression line.However, since it is calculated with the variability of thedata in mind, its formulation is not as straight forward asour usual notion of slope.
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Simple Linear Regression FormulasFor Calculating a and b
a = y - b x
b =xy- n(y)(x)
x - n(x2 2
)
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Problem
Week Sales
1 150
2 157
3 1624 166
5 177
Question: Given the data below, what is the simple linearregression model that can be used to predict sales infuture weeks?
Question: Given the data below, what is the simple linearregression model that can be used to predict sales infuture weeks?
A Fi t i th li i f l48
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Week Week*Week Sales Week*Sales
1 1 150 1502 4 157 314
3 9 162 486
4 16 166 664
5 25 177 885
3 55 162.4 2499
Average Sum Average Sum
b = xy - n( y)(x)x - n(x
= 2499 - 5(162.4)(3 ) =
a = y - bx =162.4 - (6.3)(3) =
2 2 =
) ( )55 5 96310
6.3
143.5
Answer: First, using the linear regression formulas, wecan compute a and b
Answer: First, using the linear regression formulas, wecan compute a and b
49
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yt = 143.5 + 6.3x
180
Period
135140145
150
155
160
165
170
175
1 2 3 4 5
Sa
les Sales
Forecast
The resulting regressionmodel is:
Now if we plot the regression generated forecasts
against the actual sales we obtain the following chart:
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r = 1 -S
S
xy
2
2
y
Correlation Analysis
Mathematically, correlation coefficient is defined by:
Where:Syx
2 is the standard error of the estimated regression
equation of the y values on x, and
Sy2 is the standard error for the y values
Correlation analysis measures the degree of relationshipbetween normally distributed dependent and
independent variables and is signified by the correlation
coefficient r.
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Multiple Regression
With multiple regressions, we can use more than onepredictor.
The forecast takes the form:
Y = 0 + 1X1 + 2X2 + . . .+ nXn,
Where:
0 is the intercept, and
1, 2, . . . n are coefficients
representing the contributionof the independent variables
X1, X2,..., Xn.
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All forecasts have errors.
However, the error in a
forecast should be within
confidence limits.
The error can be measured
by or described by the
standard error, the meanabsolute deviation, or the
variance.
ForecastingErrors
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Forecast AccuracySource of forecast errors:
Model may be inadequate
Irregular variations Incorrect use of forecasting
technique
Random variation
Key to validity is randomness Accurate models: random
errors
Invalid models: nonrandom
errors
Key question: How to determine if
forecasting errors are random?
Prof. Upendra KachruProf. Upendra Kachru
Forecasting
Errors
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Error measuresError - difference between actual
value and predicted value
Mean Absolute Deviation(MAD) - Average absolute
error Mean Squared Error (MSE) -Average of squared error
Mean Absolute PercentError (MAPE) - Averageabsolute percent error
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ErrorMeasurements
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MAD =Actual forecast
n
MSE = Actual forecast)
-1
2
n
(
Actual Forecast 100Actual
MAPEn
=
Prof. Upendra KachruProf. Upendra Kachru
Forecasting Error Formulae
MAD Ch t i ti
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1 M A D 0.8 standard deviation
1 standarddeviation 1.25 M AD
The ideal MAD is zero which would mean there is no
forecasting error
When the error is less than three standard deviations, itis considered as an acceptable forecast.
= (/2) x MAD 1.25 MAD
Where is the standard deviation
The larger the MAD, the less the accurate the resultingmodel
MAD Characteristics
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MAD Problem (1)
Month Sales Forecast
1 220 n/a
2 250 255
3 210 205
4 300 320
5 325 315
Question: What is the MAD value given theforecast values in the table below?Question: What is the MAD value given theforecast values in the table below?
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Solution
MAD =
A - F
n=
40
4= 10
t tt=1
n
Month Sales Forecast Abs Error 1 220 n/a
2 250 255 5
3 210 205 5
4 300 320 20
5 325 315 10
40
Note that by itself, the MADonly lets us know the meanerror in a set of forecasts
Note that by itself, the MADonly lets us know the meanerror in a set of forecasts
= 1.25 MAD = 12.5; 3 =37.5
All readings are within limits
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Example (2)
P erio d Actual Forecast (A-F) |A-F| (A-F)^2 (|A-F|/Actual )*1
1 217 215 2 2 4 0.
2 213 216 -3 3 9 1.
3 216 215 1 1 1 0.
4 210 214 -4 4 16 1.
5 213 211 2 2 4 0.
6 219 214 5 5 25 2.
7 216 217 -1 1 1 0.
8 212 216 -4 4 16 1.
-2 22 76 10.
MAD= 2.75
MSE= 10.86
MAPE= 1.28
MAD = 22/8 = 2.75
MSE = 76/7 = 10.86
MAPE = 10.26/8 =10.86
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Tracking Signals
Depending on the number of MADs selected, the TS can be used like a quality control chartindicating when the model is generating too much error in its forecasts.
The TS formula is:
The Tracking Signal or TS is a measure
that indicates whether the forecastaverage is keeping pace with anygenuine upward or downward changesin demand.
MAD
demand)Forecast-demand(Actualn
1
i=i
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Control Charts
A control chart is: A visual tool for monitoring forecast errors
Used to detect non-randomness in errors
Forecasting errors are in control if All errors are within the control limits
No patterns, such as trends or cycles, are present
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Controlling the forecast
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Control charts
Control charts are based on the following assumptions: when errors are random, they are Normally distributed
around a mean of zero.
Standard deviation of error is
95.5% of data in a normal distribution is within 2 standard
deviation of the mean
99.7% of data in a normal distribution is within 3 standard
deviation of the mean
Upper and lower control limits are often determine via
MSE
0 2 0 3MSE or MSE
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Example
Compute 2s control limits forforecast errors to determine ifthe forecast is accurate.
-6.59
-4.59
-2.59
-0.59
1.41
3.41
5.41
0 10
3.295
2 6.59
s MSE
s
= =
=
Prof. Upendra KachruProf. Upendra Kachru
Errors are all
between -6.59 and
+6.59No pattern is
observed
Therefore,
according to
control chartcriterion, forecast
is reliable
(Refer Slide 42)
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CPFR is forecasting based on
the concept of supply chain
management. It is a business
model that takes a holistic
approach to supply chain
management and information
exchange among tradingpartners.
It uses common metrics,
standard language, and firm
agreements to improve supplychain efficiencies for all
participants.
CollaborativePlanning
Forecasting andReplenishment(CPFR)
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In other words, CPFR isbased on considering the
entire supply chain orpartnerships as a single unitand the sharing of informationbetween the links in the chain.
The objective is to
collectively, as members ofthe supply chain, meet theneeds of the final consumer.
This is accomplished bysupplying the right product atthe right place, right time andright price to the customer.
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CPFR usually begins with identifying a forecasting
champion. The forecasting champion can be it a single
person, a department, or a firm.
A forecast collaboration group is formed with each organization
choosing its member in this group. Group members shouldrepresent a variety of functional areas including sales,
marketing, logistics/operations, finance, and information
systems.
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The driving premise of CPFR is
that all supply chain participants
develop a synchronized forecast.A company can collaborate with
numerous other supply network
members both upstream and
downstream in the supply
network.
Every participant in a CPFR
process supplier,
manufacturer, distributor, retailer
can view and amend forecastdata to optimize the process from
end to end.
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Special Long-Term ForecastMethodologies
1. Identify and analyze the
organizational issues that
will provide the decisionfocus
2. Specify the key decision
factors
3. Identify and analyze the keyenvironmental forces
4. Establish the scenario logics
5. Select and elaborate the
scenario6. Interpret the scenario for
their decision implications
ScenarioPlanning
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Qualitativeapproach
(Judgmental)
Historical Analogy
Method
Executive Opinion
Method
Survey Methods
The Delphi Method
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Usually based on judgmentsUsually based on judgmentsabout causal factors thatabout causal factors that
underlie the demand ofunderlie the demand of
particular products or servicesparticular products or services
Do not require a demandDo not require a demand
history for the product orhistory for the product orservice, therefore are usefulservice, therefore are useful
for new products/servicesfor new products/services
Approaches vary inApproaches vary in
sophistication fromsophistication from
scientifically conductedscientifically conducted
surveys to intuitive hunchessurveys to intuitive hunches
about future eventsabout future events
Qualitative ApproachesQualitative Approaches
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Executive Opinion MethodExecutive Opinion Method
TechniqueTechnique Low SalesLow Sales High SalesHigh Sales
ManagersManagersOpinionOpinion
40.7%40.7% 39.6%39.6%
ExecutivesExecutivesOpinionOpinion
40.7%40.7% 41.6%41.6%
Sales ForceSales ForceCompositeComposite
29.6%29.6% 35.4%35.4%
Number inNumber in
SampleSample
2727 4848
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How to choose the right Tool
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Operations
Management
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