Forecasting

IT IS THE PROCESS OF PREDICTING FUTURE EVENTS. BY

USING VARIOUS QUALITATIVE AND QUANTITATIVE
METHODS.
UNDERLYING BASIS OF ALL BUSINESS DECISIONS :
PRODUCTION, INVENTORY ETC.
Strategic importance of
Forecasting
 Good forecast are of critical importance in all
aspects of a business. Forecast is the only
estimate of demand until actual demand is
known.
 Product forecast have impacts on several
activities of an organisation like:
 Human Resources
 Capacity

 Supply Chain Management

Human Resources

 Hiring , training and laying off workers : these all

depends upon the anticipated demand.

Demand forecast is the determinant for the decisions

like : Hiring and training etc.
Capacity

 Inadequate capacity/capacity shortage of an

organisation results in the factors like ;
 Loss of customers
 Loss of Market
 Undependable delivery
Supply Chain Management

 Good Supplier relationship

 Price advantage for material
Depends upon the accurate forecast.
As extensive components of Boeing 787
jets are manufactured in dozens of
countries
“ Coordination driven by forecast is
essential “
Seven Steps in Forecasting
System
 Determine the use of forecast.
 Select the item to forecasting.
 Determine time horizon of forecast.
 Select the forecasting models.
 Gather the data needed to make the forecast.
 Make the Forecast.
 Validate and implement the result.
 These steps present a systemic way of initiating, designing
and implementing forecast.
 Forecasting – Time Horizon
 On the basis of time horizon, Forecasting is of three types :
 Short Range Forecast:
 Time span up to one year but generally less than 3 months.
 This forecast is used for planning, purchasing, job scheduling , job
assignment and determining the production level etc.
 Medium Range Forecast :
 Intermediate forecast ranging from 3 months to 3 years.
 Usefulfor the purposes : Sales planning, production planning and
budgeting analysis of various operational plans.
 Long Range Forecast :
 It is 3 years or more in time span.
 Thisforecast is used for the purposes like : planning for the new
product, capital expenditure, facility location, Research and
Development etc.
 Difference between Short Range and Long
Range Forecasting
 Short Range forecasting employs quantitative techniques for
production. It uses the techniques like :
 Moving average method,
 Exponential smoothing
 Trend extrapolation etc.
 Short term forecast is more accurate as it is for small time
horizon.
 Long range forecast deals with more comprehensive issues and
support management decisions regarding planning and products,
plants and processes. Generally based on qualitative techniques.
Types of Forecast
 Forecasting can be categorised as :
 Economic Forecast
 Technological Forecast
 Demand Forecast
Economic Forecast
 It addresses the business cycle by predicting various
features like :
 Inflation rates
 Money supply etc.
It is helpful for the organisation to prepare medium and
long term forecast.
Technological Forecast

 These are concerned with technological progress which

result in the birth of executing a new product.
 Predict rate of technological progress
 Impacts development of new products
 Long term forecast are concerned with the rate of
technological forecast.
Demand Forecast
 Predict sales of existing products and services
 These are useful for the projection of demand for a
company’s product or services over a period of time.
 Serve as an input to financial, marketing and
personal planning.
 Demand forecasting is made in the introductory
phase of a product.
 Forecasting approach
 Qualitative Method
 Used when situation is vague and little data exist. It is used
for the
 New product and new technology _ going to be
introduced.
 It involve : intuition , personal experience and value
system in reaching a forecast.
 Quantitative Method
 Used when situation is stable and historical data exist of the
existing product and current technology.
 Forecast that employee one or more mathematical techniques.
Such as sales of LCD and LED televisions by LG.
 An Overview of the Qualitative
Methods

 Jury or Executive opinion

 Delphi Method

 Sales Force Composite

 Customer Market Survey

Jury of Executive Opinion

 Involves small group of high-level experts and managers

 Group estimates demand by working together
 Combines managerial experience with statistical models
 Relatively quick
 ‘Group-think’
disadvantage
 Sales Force Composite

 Each salesperson projects his or her sales

 Combined at district and national levels
 Sales reps know customers’ wants
 Tends to be overly optimistic
 Delphi Method

 Iterative group process, Decision Makers

continues until consensus (Evaluate responses and
is reached make decisions)

 3 types of participants
 Decision makers
 Staff Staff
(Administering
 Respondents survey)

Respondents
(People who can make
valuable judgments)
Consumer Market Survey

 Ask customers about purchasing plans

 What consumers say, and what they actually do
are often different
 Sometimes difficult to answer
 Overview of Quantitative
Approaches

1. Naive approach
Time-
2. Moving averages Series
3. Exponential smoothing Model
4. Trend projection Associative
5. Linear regression Model
 Time Series Model
1. A Technique that uses a series of past data points to
make a forecast.
2. It require Set of evenly spaced (weekly, monthly,
quarterly) numerical data
1. Assumes that factors influencing past and present will
continue to influence in future
3. Forecast based only on past values, no other variables
are important
1. Obtained by observing responses at regular time
periods
Time Series Components

Trend Cycles

Seasonal Random
Trend Component

 It is the gradual upward or downward

movement of data over time.
 Changes due to population, technology, age,
culture, etc.
 Seasonal Component
 It is the data pattern that repeats itself after a period
of days, weeks, months or quarter.
 Due to weather, customs, etc.
 Occurs within a single year .
 There are six common seasonality pattern

Number of
Period Length Seasons
Week Day 7
Month Week 4-4.5
Month Day 28-31
Year Quarter 4
Year Month 12
Year Week 52
 Cyclical Component

1. Cycles are the pattern in which data that occur every

several years.
2. Repeating up and down movements
3. Affected by business cycle, political, and economic
factors
4. Often causal or
associative
relationships

0 5 10 15 20
 Random Component

 These are the blips in the data caused by

an unusual situation.
 Erratic, unsystematic, ‘residual’
fluctuations
 Due to random variation or unforeseen
events
 They follow no discernible
pattern, so can’t be predicted.

M T W T
 Naive Approach
 The simplest way to forecast is to assume that
demand in next period is the same as
demand in most recent period.
 e.g., If January sales were 68, then February sales
will be 68.
 Sometimes cost effective and efficient
 It provide a starting point against which a
more sophisticated model that follow can be
compared.
 Moving Average Method
 A forecasting method that uses an average of the n most recent
period.
 Used if little or no trend
 Used often for smoothing
 Provides overall impression of data over time

∑ demand in previous n periods

Moving average = n
Moving Average Example
Actual 3-Month
Month Shed Sales Moving Average
January 10
February 12
March 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
Graph of Moving Average
Moving Average
Forecast
30 –
28 –
Actual Sales
26 –
24 –
Shed Sales

22 –
20 –
18 –
16 –
14 –
12 –
10 –
| | | | | | | | | | | |
J F M A M J J A S O N D
 Weighted Moving Average

 Used when trend is present

 Older data usually less important
 Weights based on experience and intuition

∑ (weight for period n)

Weighted x (demand in period n)
=
moving average ∑ weights

Exercise 3.1a, 3.2b, 3.5a,3.6,3.8a,3.10a,3.13b,3.47b

 Weights Applied Period
Weighted Moving Average 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
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19
June 23
July 26

Exercise 3.1b, 3.2c, 3.5c,3.6,3.7,3.10b

 Potential Problems With
Moving Average
 Increasing the size of n ( the number of periods averaged)
smoothes the fluctuations better, but makes it makes the method
less sensitive to changes
 Do not pick the trends very well. Because they are averages.
 Require extensive record of the past data
Exponential Smoothing
 It is a sophisticated weighted moving average method that is easy to
use. It involves very little record keeping of the past data.
 Requires smoothing constant ()
 Value Ranges from 0 to 1
 Exponential Smoothing

= Last period’s forecast

+ a (Last period’s actual demand
– Last period’s forecast)

Ft = Ft – 1 + a(At – 1 - Ft – 1)

where Ft = new forecast

Ft – 1 = previous forecast
a = smoothing (or weighting)
constant (0 ≤ a ≤ 1)
 Exponential Smoothing Example

Predicted demand = 142 Ford Mustangs

Actual demand = 153
Smoothing constant a = .20

New forecast = 142 + .2(153 – 142)

144.2 ≈ 144 cars

Exercise 3.1c, 3.3, 3.43.5d,3.6,3.9d,3.11,3.12,3.13a,3.17

 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
Common Measures of Error

Mean Absolute Deviation (MAD)

∑ |Actual - Forecast|
MAD =
n

Mean Squared Error (MSE)

∑ (Forecast Errors)2
MSE =
n
Comparison of Forecast Error

Rounded Absolute Rounded Absolute

Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
Comparison of Forecast Error
∑ |deviations|
Rounded Absolute Rounded Absolute
MADActual
= Forecast Deviation Forecast Deviation
Tonnage n
with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1
For a =
180
.10 175 5.00 175 5.00
2 168 = 82.45/8
175.5 = 10.31
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For a 175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 = 98.62/8
175.02 = 12.33
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
Comparison of Forecast Error
∑ (forecast
Rounded
errors) 2
Absolute Rounded Absolute
MSE = Actual Forecast Deviation Forecast Deviation
Tonnage n
with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1
For a 180
= .10 175 5.00 175 5.00
2 = 1,526.54/8
168 175.5 = 190.82
7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 For a 175
= .50 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 = 1,561.91/8
205 175.02 = 195.24
29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
Comparison of Forecast Error

Rounded Absolute Rounded Absolute

Actual Forecast Deviation Forecast Deviation
Tonnage with for with for
Quarter Unloaded a = .10 a = .10 a = .50 a = .50
1 180 175 5.00 175 5.00
2 168 175.5 7.50 177.50 9.50
3 159 174.75 15.75 172.75 13.75
4 175 173.18 1.82 165.88 9.12
5 190 173.36 16.64 170.44 19.56
6 205 175.02 29.98 180.22 24.78
7 180 178.02 1.98 192.61 12.61
8 182 178.22 3.78 186.30 4.30
82.45 98.62
MAD 10.31 12.33
MSE 190.82 195.24
MAPE 5.59% 6.76%
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
^ where y = computed value of the variable to be
predicted (dependent variable)
a = y-axis intercept
b = slope of the regression line
x = the independent variable
Least Squares Method

Actual observation Deviation7

Values of Dependent Variable

(y value)

Deviation5 Deviation6

Deviation3

Deviation4

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

Time period Figure 4.4

Least Squares Method

Actual observation Deviation7

Values of Dependent Variable

(y value)

Deviation5 Deviation6

Deviation3
Least squares method minimizes the sum of
the squared errors (deviations)
Deviation4

Deviation1
Deviation2
Trend line, y^ = a + bx

Time period Figure 4.4

Least Squares Method
Equations to calculate the regression variables

^
y = a + bx

Sxy - nxy
b=
Sx2 - nx2

a = y - bx
Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
2001 1 74 1 74
2002 2 79 4 158
2003 3 80 9 240
2004 4 90 16 360
2005 5 105 25 525
2005 6 142 36 852
2007 7 122 49 854
∑x = 28 ∑y = 692 ∑x2 = 140 ∑xy = 3,063
x=4 y = 98.86

∑xy - nxy 3,063 - (7)(4)(98.86)

b= = = 10.54
∑x - nx
2 2 140 - (7)(4 )
2

a = y - bx = 98.86 - 10.54(4) = 56.70

Least Squares Example
Time Electrical Power
Year Period (x) Demand x2 xy
1999 1 74 1 74
2000 2 79 4 158
2001 The trend
3 line is 80 9 240
2002 4 90 16 360
^
2003 y5= 56.70 + 10.54x
105 25 525
2004 6 142 36 852
2005 7 122 49 854
Sx = 28 Sy = 692 Sx2 = 140 Sxy = 3,063
x=4 y = 98.86

Sxy - nxy 3,063 - (7)(4)(98.86)

b= 2 = = 10.54
Sx - nx 2 140 - (7)(4 )
2

a = y - bx = 98.86 - 10.54(4) = 56.70

Associative Forecasting
Used when changes in one or more independent
variables can be used to predict the changes in the
dependent variable

Most common technique is linear

regression analysis
Associative Forecasting

Forecasting an outcome based on predictor

variables using the least squares technique

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

Sales Local Payroll

($ millions), y ($ billions), x
2.0 1
3.0 3
2.5 4
2.0 2 4.0 –
2.0 1
3.0 –
3.5 7 Sales
2.0 –

1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll
Associative Forecasting Example

Sales, y Payroll, x x2 xy
2.0 1 1 2.0
3.0 3 9 9.0
2.5 4 16 10.0
2.0 2 4 4.0
2.0 1 1 2.0
3.5 7 49 24.5
∑y = 15.0 ∑x = 18 ∑x2 = 80 ∑xy = 51.5

∑xy 51.5 - (6)(3)(2.5)

x = ∑x/6 = 18/6 = 3 b = - nxy = = .25
∑x2 - nx2 80 - (6)(3 )
2

y = ∑y/6 = 15/6 = 2.5 a = y - bx = 2.5 - (.25)(3) = 1.75

 Associative Forecasting Example

^
y = 1.75 + .25x Sales = 1.75 + .25(payroll)

If payroll next year is

estimated to be $6 billion, 4.0 –
then:
3.25
3.0 –
Sales

Sales = 1.75 + .25(6) 2.0 –

Sales = $3,250,000
1.0 –
| | | | | | |
0 1 2 3 4 5 6 7
Area payroll