Forecasting
● Forecast is an important element in making informed decisions.
- It plays an important role in the planning process because they enable managers to
anticipate the future so they can plan accordingly.
➢ Forecast is the basis for budgeting, planning capacity, sales, production and
inventory, personnel, purchasing, and more.
- Wherein it affects decisions and activities throughout an organization.
● Forecasting is the art and science of predicting future events.
➢ It is a statement about the future value of a variable of interest.
- and provides information about the potential future events, such as future
financial outcomes and trends, together with its possible consequences in the
organization.
➢ Forecasting is also called “Statistical Analysis”.
- Since forecasting uses various statistical techniques or tools in predicting future
demand based on past demand information, wherein it may result in a subjective
or an intuitive prediction.
● Two Important Aspects of Forecasts
1. Expected level of demand - the expected level of demand can be a function of
some structural variation, such as a trend or seasonal variation.
- This means that the expected level of demand for a product or service is not
static but can be influenced by identifiable patterns or changes over time. These
patterns refer to structural variations, which includes factors such as trends and
seasonal variations.
➢ A trend is the long-term movement or direction in demand over time,
which can either increase, decrease, or remain constant.
➢ Seasonal variation refers to periodic and predictable changes in demand
due to seasonal factors, such as time of year, holidays, or weather
patterns.
2. Accuracy (to be edited) - It is related to the potential size of forecast error.
● Forecast accuracy measures how close the forecasted values are to the actual
observed values.
○ and reduces errors in decision-making and minimizes costs associated
with incorrect forecasts.
➢ Forecast error is the difference between the value that occurs and the
value that was predicted for a given time period, which has two types:
positive error and negative error.
- Positive errors result when the forecast is too low, negative errors when
the forecast is too high.
● Common Features
1. Techniques assume some underlying causal system that existed in the past
will persist into the future.
- Most forecasting models are based on the idea that past patterns and
relationships, such as trends, cycles, or seasonal variations will continue into the
future. This assumption works well in stable environments but can fail when there
are significant disruptions or changes in the underlying system, such as natural
disasters and technological breakthroughs.
2. Forecasts are not perfect.
- predicted values usually differ from actual results. Forecasts inherently involve
uncertainty, as they rely on predictions about future events that are influenced by
multiple and unpredictable factors. Since forecasting models cannot eliminate
error but aim to minimize it
3. Forecasts for groups of items are more accurate than those for individual
items.
- When forecasting for a group, the random variations or fluctuations in individual
items tend to balance each other out. This means that if one item performs
unexpectedly high and another performs unexpectedly low, their effects can
cancel each other out to some extent. As a result, the combined or overall
forecast for the group becomes more accurate compared to forecasting each
item individually.
4. Forecast accuracy decreases as the forecasting horizon increases.
- Short-term forecasts are generally more accurate because the influencing factors
are more predictable and stable. As time passes, uncertainty can grow, making
long-term forecasts less reliable.
Other Forecasting Methods
● Focus Forecasting - is a practical and results-oriented forecasting method that
emphasizes using the best-performing forecasting technique for a given situation, rather
than committing to a single method.
➢ Some companies use forecasts based on a “best current performance” basis.
○ Apply several forecasting methods, (such as moving averages and
exponential smoothing) to the last several periods of historical data.
○ The method with the highest accuracy (or best historical performance) is
used to make the forecast for the following period.
● Diffusion Models - are used to forecast the adoption and spread of new products,
particularly when historical data are unavailable. They estimate future growth by drawing
analogies with established products and accounting for factors that influence adoption.
Here's a breakdown of the key concepts in diffusion models:
➢ Historical data on which to base a forecast are not available for new products.
➢ Predictions are based on rates of product adoption and usage spread from other
established products.
➢ Key Concepts of Diffusion Models:
○ Market potential - it represents the total number of potential adopters or
the maximum adoption level a product can achieve. It is influenced by
factors such as market size, demographics, and economic conditions.
○ Attention from mass media - early adoption of new products is often
driven by promotional efforts and media coverage, which build awareness
and credibility for the product.
○ Word-of-mouth - plays a significant role in later stages as satisfied users
influence others in their network to adopt the product
Using Forecast Information - to guide decision-making can follow one of two primary
approaches
● Reactive approach - It views forecasts as probable future demand, and a manager
reacts to meet that demand.
- In the reactive approach, forecasts are treated as a representation of probable
future demand, wherein managers focus on adjusting operations, resources, or
inventory to meet the projected demand.
- The organization responds to demand as it materializes, rather than trying to
change it. This approach is effective in predictable markets where demand
patterns are consistent or only slightly variable.
● Proactive approach - It seeks to actively influence demand and requires either an
explanatory model or a subjective assessment of the influence on demand.
- An explanatory model: uses data-driven insights to understand the drivers of
demand and the impact of interventions.
- Subjective assessment: leverages managerial intuition or expert opinions to
guide decisions.
- it includes strategies like promotions, advertising, price changes, or new product
features to stimulate demand.
- It aligns the company's operations with desired market conditions, rather than
just adapting to existing ones.
So in summary Forecasting is the process of predicting future events, trends, or outcomes
based on historical data, current conditions, and analysis.
and it has 2 approaches which are qualitative and quantitative and under these techniques there
are different methods in order to identify information that is needed and will be used in decision
making, so qualitative technique includes expert opinions and judgment while quantitative
technique includes or uses mathematical models and historical data.
