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Spring 08-09 MS 401 - Production and Service Systems Operations Forecasting Murat Kaya FENS, Sabanci University Murat Kaya, Sabancı Üniversitesi 1 Spring 08-09 Predicting the Future • “My concern is with the future since I plan to spend the rest of my life there” C. F. Kettering • Hertz: How many cars will be rented during March 2008? • Apple: How many iPod Nano 8GB will be sold in 2008? • Why is it important to know the answers to these questions? Murat Kaya, Sabancı Üniversitesi 2 Spring 08-09 If Forecasting Fails • Cisco could not forecast the demand for networking equipment correctly – result: lost $2.5 billion due to unsold products • Volvo – Green car example (mid 1990s) – excessive amount of green color cars in the middle of the year – to sell these cars, marketing offered special promotions and discounts Murat Kaya, Sabancı Üniversitesi 3 Spring 08-09 Forecasts Forecast: An estimate of the future level of some variable Characteristics of Forecasts • They are usually wrong – the planning systems that use forecasts should be robust • A good forecast is more than a single number – include some measure of anticipated error • Aggregate forecasts are more accurate • The longer the forecast horizon, the less accurate the forecast will be • Forecasts should not be used to the exclusion of known information – some information may not be present in the past history Murat Kaya, Sabancı Üniversitesi 4 Spring 08-09 Time Series Methods • Time series: A collection of observations of some economic or physical phenomenon drawn at discrete points in time • The idea: Information can be inferred from the pattern of past observations and can be used to forecast the future value of the series • Patterns in time series – trend: tendency of a time series to exhibit a stable pattern of growth or decline – seasonality: having a pattern that repeats in fixed intervals – cycles: similar to seasonality, but the length and the magnitude of the cycle may vary – randomness: when there is no recognizable pattern to the data Murat Kaya, Sabancı Üniversitesi 5 Spring 08-09 Time Series Patterns Copyright © 2001 by The McGraw-Hill Companies, Inc Murat Kaya, Sabancı Üniversitesi 6 Spring 08-09 Evaluating Forecasts D1 , D2 , D3 , ..., Dt , ... observedvaluesof demand Ft : forecastmade for periodt in periodt-1 Forecasterror: et Ft Dt Measuresof ForecastAccuracy 1 n MAD ei n i 1 1 n 2 MSE ei n i 1 1 n ei MAPE 100 n i 1 Di Murat Kaya, Sabancı Üniversitesi 7 Spring 08-09 Random versus Biased Forecast Errors Copyright © 2001 by The McGraw-Hill Companies, Inc Murat Kaya, Sabancı Üniversitesi 8 Spring 08-09 Forecasting Stationary Time Series • Stationary time series: Each observation can be represented by a constant plus a random fluctuation Dt t • • Two methods – moving averages (MA) – exponential smoothing (ES) Murat Kaya, Sabancı Üniversitesi 9 Spring 08-09 Moving Averages (MA) • A moving average of order N is the arithmetic average of the most recent N observations 1 t 1 Ft Di N i t N 1 Dt 1 Dt 2 ... Dt N N • When calculating the forecast for the following period (period t+1), we do not need to recalculate the N-period average because 1 Ft 1 Ft Dt Dt N N • Example 2.2 Murat Kaya, Sabancı Üniversitesi 10 Spring 08-09 Moving Average Lags Behind the Trend Murat Kaya, Sabancı Üniversitesi 11 Spring 08-09 Exponential Smoothing (ES) • The current forecast is the weighted average of the current observation of demand and the last forecast Ft Dt 1 1 Ft 1 Substituting Ft 1 Dt 2 1 Ft 2 we obtain Ft Dt 1 1 Dt 2 1 Ft 2 2 Continuingin thisway, we get Ft 1 Dt i 1 i i 0 • High α: forecast reacts better, however it is less stable – Murat Kaya, Sabancı Üniversitesi 12 Spring 08-09 Weights in Exponential Smoothing Copyright © 2001 by The McGraw-Hill Companies, Inc Murat Kaya, Sabancı Üniversitesi 13 Spring 08-09 Exponential Smoothing with Different α Values Copyright © 2001 by The McGraw-Hill Companies, Inc Murat Kaya, Sabancı Üniversitesi 14 Spring 08-09 Example 2.3 from Nahmias • Observed number of failures: – 200, 250, 175, 186, 225, 285, 305 190 • Assume F1 was 200 • Using α=0.1 (we need a starting value) F2 D1 1 F1 200 The forecasts are quite stable due to low α Murat Kaya, Sabancı Üniversitesi 15 Spring 08-09 In-Class Exercise Handy, Inc. produces a calculator that experienced the following monthly sales history for the first four months of the year: Jan:23.3; Feb: 72.3; March: 30.3; April: 15.5 a) If the forecast for January was 25, determine the one-stepahead forecasts for February, March, April and May using exponential smoothing with α=0.15 b) Repeat the calculations using α=0.40 c) Compute the MSEs for the forecasts in parts (a) and (b) Murat Kaya, Sabancı Üniversitesi 16 Spring 08-09 Solution - 1 Ft = Dt-1 + (1-)Ft-1 Murat Kaya, Sabancı Üniversitesi 17 Spring 08-09 Solution - 2 Murat Kaya, Sabancı Üniversitesi 18 Spring 08-09 Similarities Between Moving Averages and Exponential Smoothing • Stationary demand assumption – can also handle shifts in demand (will adjust) • Single parameter: N, α – small N or large α results in • greater weight on current data • more responsive forecasts • Not effective in catching trends – both lag behind trends Murat Kaya, Sabancı Üniversitesi 19 Spring 08-09 Differences Between Moving Averages and Exponential Smoothing • – ES assigns weight to all past data points – MA uses only the latest N • – ES requires only the latest data point – MA requires to save N past data points Murat Kaya, Sabancı Üniversitesi 20 Spring 08-09 Forecasting Time Series with Trend • Two methods – regression analysis (we will not cover) • fits a straight line to a set of data – double exponential smoothing (Holt’s method) • simultaneous smoothing on the series and the trend Murat Kaya, Sabancı Üniversitesi 21 Spring 08-09 Double Exponential Smoothing Using Holt’s Method T heτ - step- aheadforecastmade in period t : Intercept Slope Ft ,t St Gt St Dt 1 St 1 Gt 1 Gt St St 1 1 Gt 1 • Initialization issue: The best way is to use some initial period data to estimate the initial intercept (S0) and slope (G0) Murat Kaya, Sabancı Üniversitesi 22 Spring 08-09 Example 2.5 from Nahmias • Observed number of failures: 200, 250, 175, 186, 225, 285, 305, 190 • Assume S0 = 200, G0 = 10. Use α=0.1, β=0.1 t Ft-1,t (forecasted) Dt (actual) St (intercept) Gt (slope) 0 --- --- 200.0 10.0 1 210.0 200 209.0 9.9 2 218.9 250 222.0 10.2 3 232.2 175 226.5 9.6 4 236.1 186 … … 5 240.3 225 … … 6 247.7 285 … … • Multi-step ahead forecast: F2,5=S2+(3)G2=222+(3)(10.2)=252.6 Murat Kaya, Sabancı Üniversitesi 23 Spring 08-09 Forecasting Seasonal Series • A seasonal series is a series that has a pattern repeating every N periods (length of the season) • Note that this is different than using “season” to refer to a time of the year • To model seasonality, use seasonal factors: c1, c2 ,...,cN where c t N • ct represents the average amount that the demand in the tth period of the season is above or below the overall average • We will study the Winter’s method – triple exponential smoothing Murat Kaya, Sabancı Üniversitesi 24 Spring 08-09 Winter’s Method: Seasonal Series with Increasing Trend Copyright © 2001 by The McGraw-Hill Companies, Inc Murat Kaya, Sabancı Üniversitesi 25 Spring 08-09 Winter’s Method • Assume a model of the form Dt Gt ct t Ft ,t St Gt ct N Trend Seasonal factors Murat Kaya, Sabancı Üniversitesi Dt 1 St 1 Gt 1 St ct N Gt St St 1 1 Gt 1 Dt ct St 1 ct N 26 Spring 08-09 Winter’s Method: Initialization Procedure • • • • Check Nahmias, page 85 for details Use at least two seasons of data (2N data) Calculate the sample means for the two seasons V1, V2 Calculate the initial slope estimate G0 – • Calculate the initial intercept estimate S0 – • Calculate the initial seasonal factors – – find the average of each seasonal factor – normalize the seasonal factors (so that they sum up to 1) Murat Kaya, Sabancı Üniversitesi 27 Spring 08-09 Example 2.8 from Nahmias • The data set: 10, 20, 26, 17, 12, 23, 30, 22 Season 1 Season 2 • Initialize • Suppose that at time t=1, we observe D1=16. Update the equations using α=0.2, β=0.1, γ=0.1 • Suppose that we observe one full year of demand given by D1=16, D2=33, D3=34, D4=26. Update the equations again Murat Kaya, Sabancı Üniversitesi 28 Spring 08-09 Seasonal Demand, No Trend Copyright © 2001 by The McGraw-Hill Companies, Inc Murat Kaya, Sabancı Üniversitesi 29 Spring 08-09 Affecting the Demand • “The best way to forecast the future is to create it” Peter Drucker • “Forecasting the demand” versus “demand planning”, or “demand management” • Firms can “affect” their demand through their actions – promotions – sales effort • Encourages the retailers / wholesalers to “forward buy” • What are the effects of past promotions in the health of forecasting data? Murat Kaya, Sabancı Üniversitesi 30 Spring 08-09 Some Practical Issues • Sales data versus demand data – how can a firm capture “lost sales” ? • Forecasting demand for a new product is difficult – will it generate demand, or will it steal demand from existing products? • Forecasting assumes that history represents future. What if there are some external changes? – a new competitor • Slow-moving items are hard to forecast – sparse data Murat Kaya, Sabancı Üniversitesi 31