Chapter 4 Forecasting

Definition: Process of predicting a future event

- Underlying basis of all business decisions (Production, Inventory, Personnel, Facilities)

- Can be subjective or intuitive prediction

Forecasting Time Horizons

- Its classified by 3 FTH
- Short-range forecast
o Up to 1 year, generally less than 3 months (planning, purchasing, scheduling, job
assignments and production levels)
- Medium-range forecast
o 3 months to 3 years (Sales and production planning, budgeting)
- Long-range forecast
o 3+ years (New product planning, facility location, research and development)

Distinguishing Differences
- Medium/long-range forecasts deal with more comprehensive issues and support management
decisions regarding planning and products, plants and processes (GMs decision to open in brazil
but can take 5-8 years to complete)
- Short-term forecasting usually employs different methodologies than longer-term forecasting
(Math techniques, moving averages, less quantitative methods are useful new product)
- Short-term forecasts tend to be more accurate than longer-term forecasts, influences change
everyday

The Influence of Product Life Cycle

- A factor to consider when developing sales forecasts (longer ones)

- Product and services don’t sell at constant level most success ones pass through 4 stages
- Introduction and growth require longer forecasts than maturity and decline
- As product passes through life cycle, forecasts are useful in projecting
o Staffing levels
o Inventory levels
o Factory capacity
4 Stages: Intro, growth, maturity and decline

Type of Forecasts

- Economic forecasts
o Address business cycle – predicting inflation rate,
money supply, housing starts, etc.
- Technological forecasts
o Predict rate of technological progress results in birth of technological progress that
brings developments of new products
 - Demand forecasts
o Predict sales of existing products and services
o Projection of demand for company’s product and services called (sales forecast)
o Drives company’s production, capacity, scheduling systems and serve as inputs to
financial, marketing and personnel planning

The Strategic Importance of Forecasting

- Good forecast are of critical importance of business
- Forecast is the only estimate of demand until actual demand becomes known

- Human Resources – Hiring, training, laying off workers, if training declines quality of work
decreases
- Capacity – Capacity shortages can result in undependable delivery, loss of customers, loss of
market share
- Supply-Chain Management – Good supplier relations and price advantages

Forecasting Approaches
- 2 approaches of forecasting: Quantitative and Qualitative

Qualitative: Used when situation is vague and little data exist

- New products
- New technology
- Involves intuition, experience
- e.g., forecasting sales on internet
Jury of executive opinion
- group of high level of experts or managers often in combination with statistical model
(scientist get to together to talk about future trend of the world)
Delphi Method
- has 3 types of participants (decision makers, staff personnel and respondents)
- 5-10 experts (DM)
- Assist DM by preparing distributing, collecting and summarizing surveys (SP)
- Inputs to the decision maker before forecast is made, judgement is valued (R)
Sales force composite
- Estimates from individual salespersons are reviewed for reasonableness, then aggregated
Consumer Market Survey
- Ask the customer
Quantitative:
1. Naive approach
2. Moving averages Time-series
3. Exponential smoothing models
4. Trend projection
5. Linear regression Associative model

1) Time Series Models

- Forecasting technique that uses a series of past data points to make a forecast
- Set of evenly spaced numerical data
- Obtained by observing response variable at regular time periods
- Forecast based only on past values, no other variables important
- Assumes that factors influencing past and present will continue influence in future

Decomposition of a Time Series

- Trend: up and down movement of data, changes in pop, age distribution, or cultural view
- Seasonality: data pattern that repeats itself after period of days, weeks, months (6 common
seasonality patterns)
- Cycles: patterns in data that occur every several years, tied with short term business analysis
and planning
- Random variations: blips in data cause by chance of unusual situations, don’t have a pattern

a. Naïve Approach: Assumes that demand in the next period is equal to demand in the most recent
period
b. Moving Average: method that uses an average of the n most recent period of data to forecast
the next period
- Uses actual data values to generate, are useful when we assume data stays steady over time
∑ demand in previous n periods
Moving average =
n

N: # of periods in the moving average (4,5,6 months

Weighted Moving Average

∑ (weight for period n)
- Used when some trend might be present Weighted x (demand in period n)
- Older data usually less important moving average
- Weights based on experience and intuition ∑ weights
Simple Moving Average Problem (1)

Week Demand
1 650
2 678
3 720
4 785
5 859
6 920
7 850
8 758
9 892
10 920
A t-1 + A t-2 + A t-3 +...+A t- n
Ft = 11 789
n 12 844
• Question: What are the 3-week and 6-week moving average forecasts for demand?

• Assume you only have 3 weeks and 6 weeks of actual demand data for the respective
forecasts

F =(650+678+720)/3
4
Week Demand 3-Week 6-Week
1 650
2 678 =682.67
3 720 F =(650+678+720
7
4 785 682.67
5 859 727.67
6 920 788.00
+785+859+920)/6
7 850 854.67 768.67
8 758 876.33 802.00 =768.67
9 892 842.67 815.33
10 920 833.33 844.00
11 789 856.67 866.50
12 844 867.00 854.83

Weighted Moving Average

- The weighted moving average model assumes that different weights should be given to
each, in order to calculate the forecast
- It is used when demand pattern is stable There are different types of WMA:
- 2-Period Weighted Moving Average
- 3-Period Weighted Moving Average
- n-Period Weighted Moving Average
- The larger the number of periods, the more conservative (less dynamic) the forecast is
Potential Problems with Moving Average

- Increasing n smooths the forecast but makes it less sensitive to changes

- Does not forecast trends well
- Requires extensive historical data

Exponential Smoothing

- Form of weighted moving average

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

Measuring Forecast Error

Forecast Error = Actual Demand – Forecast Value = A1 – F1

3 most popular measures: Mean absolute deviation (MAD), mean squared error (MSE), mean absolute
percent error (MAPE)

MAD:

All on paper: